By Christos Panayiotides
In the course of my long professional career, I have heard many absurd statements made by politicians and journalists. However, what unquestionably stands out – in terms of absurdity and irrelevance – is the case of the Non-Performing Loans (NPLs).
As I have pointed out on many occasions in the past, NPLs constitute a big predicament that is difficult to solve. Regrettably, the positions taken and the solutions proposed by our politicians underline their inability to comprehend and solve the problem.
The essence of banking
To eliminate the resulting confusion, I will seek to explain in simple terms the basic parameters of the issue.
- The substance of banking operations is borrowing from depositors and lending to borrowers (in the wider context of these terms). The difference between the rate of interest charged on the loans advanced and the rate given on the deposits taken is utilised to cover the overheads of the bank and to generate a profit for the benefit of the bank’s shareholders (who contribute 10-15 per cent of the funds utilised to finance the loans given). The larger the risk of not being able to recover the loans advanced, the higher the lending rate of interest and, by extension, the short-term profit generated by the bank. That profit, however, may disappear if the loans advanced become “non-performing”. In other words, the higher the risk taken as a result of advancing loans to non-credit worthy borrowers, the higher the short-term profit recognised by a bank. Of course, these profits are reversed at the stage when the loans given become “non-performing” when the banks are forced to recognise the losses generated by the inability of the borrowers to repay the loans they have taken.
- The borrowers of a bank may be other banks or they may take the form of government bonds (instruments used by governments to borrow from banks).
- In practice, part of the deposits taken by banks may be utilised (and were, in fact, utilised by Cyprus banks) in order to participate in other banks as, for example, happened in the acquisition by Cyprus banks of foreign subsidiaries. However, on a consolidated basis, the substance of the risks assumed by the shareholders and the lenders (i.e. the depositors) of a given bank in respect of such investments remain the same; they are simply extended to overseas territories.
- Some people will rush to point out that banks undertake other activities (such as the transferring of funds from one person to another person), beyond the acceptance of deposits and the advancement of these deposits to borrowers in the form of loans. These other services, however, are of an auxiliary nature and do not change the gist of the banking function outlined above.
What happened in Cyprus?
- Cypriot banks suffered substantial losses because the loans they advanced to certain governments were subjected to a “haircut”, on the basis that they were not recoverable. A good example of such losses was the case of the Greek government bonds, which the Cypriot banks acquired, even though they were classified as “junk”, in the hope that they would thus realise an easy, quick profit. As one would expect, “junk bonds” can be purchased at a low price and in theory they yield a high return to compensate investors for the risk of losing their money, which is what happened in the end.
- Substantial additional losses were generated by Cyprus banks as a result of investing in loss-making foreign subsidiaries (in Russia, the Ukraine etc.) at prices that, at least in retrospect, proved to be much higher than their real value. These investments ended up having a negligible value, resulting in the generation of high additional losses.
- At the same time, Cyprus banks, under pressure from their employees, who comprised (and continue to comprise) a privileged class of the working population, were paying them fat salaries, rewards and other benefits, which contributed to the generation of further losses undermining the viability of the banks.
- The consequences of the above negative factors were amplified by the unstable economic climate, which was promoted by the then government of Cyprus and the inability of the supervising authorities (the Central Bank of Cyprus) to adequately supervise the Cyprus banking system.
Where have the Cypriot banks been led to?
As I have already explained, the banks finance the loans (and other forms of credit) they advance to an extent of (approximately) 85-90 per cent, by utilising the deposits they take and, to a much smaller extent, by utilising their shareholders’ capital.
Thus, when 40 per cent of the loans advanced become “non-performing” (either because of the inability of the borrowers to discharge their obligations or because they refuse to repay their loans because they expect that part of them will be “forgiven”), the affected banks cease to be in a position to repay a substantial part of the deposits taken. The situation becomes worse because as a rule, deposits have a short-medium time horizon while loans tend to be medium-long term arrangements.
The fundamental question
This all raises a fundamental question which is addressed to all those who casually argue in favour of showing “flexibility” towards the defaulting borrowers. In terms of substance, how do they propose to bridge the gap? How do they suggest that the banks should deal with their inability to repay their depositors, as a result of their own borrowers having become delinquent?
The question posed can accommodate three responses. The problem can be tackled (a) by minimising the cost of the non-performing loans (through securing their collection, despite the resistance that will be encountered and, if necessary, by liquidating the mortgages and the guarantees held); (b) by subjecting the depositors to a new haircut (similar to the previous one) and (c) with funds, which the taxpayers are called upon to dish out one way or another.
At this point, it may be appropriate to highlight the fact that the Cypriot taxpayers are not confined to rich people. Poor people also pay taxes on consumption such as VAT, taxes on petrol (electricity) etc. In contrast, one could hardly call “tax-payers” those who systematically evade their tax obligations; and there are quite few of those.
The proposal of setting up a “dedicated vehicle” to manage the non-performing loans smacks of an intention to create conditions that would be conducive to “rusfeti”. There is little doubt that in a state organisation charged with the management of non-performing loans there will be ample scope for politicians to indulge in “rusfetology”. Very much like the banks did in the past – providing as a result of political interventions shaky loans to non-credit worthy borrowers – the non-performing loans of borrowers who can pull the right strings are likely to end-up being forgiven. On this basis, it is very easy to understand the recently noted unanimity on the subject amongst all the political parties!
What needs to be done
Yes, by all means, let’s protect the home (say, up to 50 square metres and provided that the borrower or his/her guarantor does not have any income or other assets). Anything beyond this is suspect, and it will end up burdening – again – either the bank depositors or the people at large, through increased taxes or a combination of the two.
The procedures that need to be prescribed for securing such protection should be simple, readily comprehensible and incapable of being subjectively interpreted, depending on who the bankrupt borrower is. A precondition for affording such protection should be a public statement (stored in a dedicated data bank that will be readily accessible on the internet), disclosing all the assets and all the income of the borrower, of his/her spouse and of their underage children. An explicit statutory provision should be made to the effect that, if such declarations prove to be materially incorrect at any point in time, the protected property shall be foreclosed forthwith for the benefit of those who suffered the cost of the protection given.
If we genuinely wish to make progress, we must force the politicians to stop taking the people for a ride. In this process, journalists have an important role to play. As a minimum, they should seek and secure an in-depth understanding of the issues they handle and they should adequately explain them to their audience. In this respect, the publicly owned media must do much more than they have done thus far.
Christos Panayiotides is a regular columnist writing in the Cyprus Mail and in Alithia