IN A MARKET economy, the fate of businesses that fail is bankruptcy. If a business cannot pay its creditors, suppliers or banks, bankruptcy proceedings could be taken against it so that creditors could recover some of the money owed to them. This practice was not often followed in Cyprus, a failure that is proving very costly to the economy.
There is no better example of this market failure than the Orphanides supermarket chain collapse, which left behind debts in excess of €80 million to suppliers and in the region of €140 million to the banks. Some suppliers are now also on the verge of bankruptcy because they allowed the chain to build up huge debts that they would never be able to recover.
How much better off they would have been today if they had stopped supplying Orphanides with goods after three months of non-payment instead of allowing the building up of debt.
The banks followed a similar approach. Its main banker Laiki allowed the company to keep increasing its borrowings as long as it provided collateral. It ignored the fact that the chain was a failing business that was unable to make its loan repayments and continually needed more credit to stay afloat; the bank even had additional intelligence as many of Orphanides’ unpaid suppliers were its clients. Had Laiki followed normal banking practices it would have turned off the credit tap and commenced bankruptcy proceedings in order to recover as much of its money as it could, instead of pouring more money into it.
This is also one of the basic principles for an efficiently functioning market economy. Inefficient, loss-making enterprises that cannot make their loan repayments are depriving more efficient and more productive businesses of capital resources; they are also preventing the banks earning a return on their capital, which is the reason of their existence. If Laiki had stopped lending Orphanides money after the company’s loans reached €60m it could have given loans to companies that were more efficient and profitable, thus helping their growth.
One of the main problems now facing the Bank of Cyprus is similar to the Orphanides-Laiki experience. It is owed many hundreds of millions by big companies, many of them developers who are unable to service their loans because of the recession. It could either start selling off the assets its customers used as collateral in order to recover some of its money now that it is in a dire financial situation or do nothing and risk going bankrupt. It is a no-brainer really.
However, when last weekend the idea of splitting the BoC into two banks – one handling normal banking operations and another functioning as an assets management company – was raised it sparked a public outcry. Politicians and developers were outraged that the assets management company would sell off real estate, held as collateral for non-performing loans, at cut-rate prices to hedge funds and speculators. What the critics of the move failed to realise was that even if the bank was not split into two, it would still have to put its debtors’ assets on sale. There is no escaping this, regardless of the form the bank would take, because the bank would be in desperate need of cash. It cannot hold on to real estate in the hope that in two or three years’ time it would be able to get a better price for it or the debtor would resume loan repayments. It needs to raise money now in order to increase its liquidity and be able to give loans to new businesses that would earn it a return. It cannot hold on to real estate that earns nothing when it is cash-strapped and unable to operate as a bank.
Developers are bound to complain, but is it anyone else’s fault that their business failed? In the market economy entrepreneurs take risks but do not always succeed. When their business fails they have to accept the consequences rather than expect the bank to hold on to their assets earning nothing from them until these can be reclaimed several years down the road. This does not happen in any properly functioning economy. And certainly not in an economy deep in recession in which the banking sector’s survival is on the line.