By Savvakis C Savvides
Politics in Cyprus reminds me of the dialogue between the Cheshire cat and Alice, in Lewis Carroll’s “Alice in Wonderland”, when Alice asks which road to follow even though she does not know where she wants to go. The cat replies: “if you don’t know where you are going any road will get you there.”
This seems to be the guiding light of our inept political leadership and it practically describes our politicians when setting economic policy. Below are what I think should be ground rules and objectives for realistic and attainable economic policy goals:
- Without setting sound foundations for the economy there can be no stable and lasting economic development.
- The biggest obstacle that holds the economy to ransom and prevents economic growth is the huge private (and public) debt.
- The “rescue” of the banks cannot by itself lead towards sustainable economic growth when companies and households are deep in debt and having balance sheets with depleted equity or even with a negative net worth.
- Non-performing loans (NPLs) are only a symptom of the real problem of the economy which is the enormous private debt.
- Therefore, any solution that may reduce the NPLs on the banks’ balance sheets but which does not reduce private debt (like, for example, the packaging and sale of loans) is not a cure and does not help economic recovery.
- Moreover, “solutions” that squander the provisions as discounts offered to prospective suitors in order to entice them to buy the loans – as sadly it seems to be the only option being considered – only make the problem of private debt worse and a lot more difficult to solve.
Serving the Establishment
The decision to encourage banks to use their provisions to offer discounts to vulture funds so as to entice them to take the loans off the banks’ balance sheets, aided by the new legal framework which in its wisdom parliament recently enacted into law, risks another financial crisis through the uncontrolled transfer of wealth and other assets pledged to the banks. Our political leadership’s submission to the banks’ wishes opens widely the door to those who are after a quick profit by raiding the banks’ balance sheets, with or without the consent of those who currently control the banks.
Undoubtedly, this short-sighted policy serves only the major shareholders who now control the banks and whose prime concern is to register an accounting profit by selling the loans within the allowed margins afforded by the sizeable provisions they are being forced to make. In this manner, the major shareholders avoid having to recapitalise the banks through providing additional equity themselves.
This road will surely lead the country to a new and much bigger economic calamity. This is because the proposed solution in no way reduces private debt. On the contrary, debt becomes entrenched as the provisions will no longer be available for loan write-offs, which are a pre-requisite for making viable restructurings. Loan provisions are hence eliminated by sacrificing them as discounts on the altar of the sale of loans to third parties.
Accommodating the banks while reducing private debt
There are however methods the banks can employ and ways through which to utilise the provisions productively in order reduce private debt and at the same time avoid what they fear most (of having to provide new capital). But in order to make this happen, we need to engage in more sophisticated and imaginative ways when structuring loans among various project parties so as to meet both the needs of the borrower and those of the shareholders of banks.
The borrower needs to have a viable project and one which takes on no more debt than they can adequately serve. The bank on the other hand needs to be assured that a restructured loan which remains on their books will not return to haunt them as a new NPL. Such arrangements could, with some transparent criteria, also include the involvement of the state, if needed, while ensuring fair play for the taxpayer.
Let me illustrate with an example. The bank should be obliged by law to offer the same discount to its client before it offers the loan on its own or in a package to a third party for purchase. The client should then be given three to six months to repay and fully settle the loan. If, say, a borrower owes the bank €500,000 and the bank proposes to sell this loan to a fund at 60 per cent discount, i.e. a purchase price of €200,000, the borrower should be formally informed of this and be given the chance to come up with the settlement amount of €200,000 plus interest within, say, six months.
There are usually two problems in the refinancing of restructurings which, in this case, will not apply or they will be greatly mitigated. One has to do with the ability of the borrower to repay the restructured loan which may not be possible in the current state of the Cyprus economy. This hurdle, however, will be greatly lowered because of the significant write off that the banks in these circumstances will be willing to make, but were not willing to risk if the loan remained on their books.
The second obstacle is usually the entanglement and commitment of the collaterals securing the existing loan. But again, since the existing loan will be settled (completely repaid), the new bank that may be financing the reduced amount needed by the client to settle his loan can have an agreement for the collaterals or some of these that guarantee the old loan to be transferred to the new financing bank. This would happen at the same time as the new loan is advanced and the old loan is completely repaid.
In the case where a bank may want to do the restructuring itself, it may opt to put into an escrow account an amount which may be as high as the total of the provisions that they may otherwise be willing to offer by way of a discount to someone who would buy the loan. The bank will have full control of this escrow account on its own, or with the government if it is a case where the state may participate to enable some viable loan restructurings. The borrower will thus be obliged to make up the reduced instalments while the bank will have enough funds set aside in the escrow account, which will act as a buffer to ensure that the new loan will not return as an NPL.
The way forward
The main objective should be to seek solutions which utilise the existing provisions to reduce private sector debt rather than waste them on discounts to third parties. Those who buy the loans only want to maximise their short-term profit, using all the leverage that the collaterals and guarantees attached to the loan as well as the new legislation affords them. The end result of this is that it will then be far easier for these non-bank entities to grab the assets of the borrowers rather than engage in write-offs, which can potentially make the repayment viable.
Innovative solutions that also aid the economy and ease the private debt burden can be found if the sensitivities and the ability of the interested parties to manage some risks are taken into account. I have personally made similar arrangements within my 30 years of studying and implementing such project finance arrangements. It is extremely difficult, however, if the politicians do not want to open their minds to new ideas and the only thing that seems to interest them is to convince the electorate that “other politicians” are to blame!
The bottom line is that solutions can be found with good will and an open mind. But this is perhaps a lot to ask from our politicians. Adapting the dialogue between Alice and the Cheshire cat, if she were to ask “which is the road that leads to economic recovery?” the cat may reply “the one that channels the provisions into productive write-offs for loans that support viable projects in the economy and hence repair the balance sheets of the people, rather than just dressing up those of the banks”.
Savvakis C Savvides is an economist, specialising in economic development and project financing. He is a former senior manager at the Cyprus Development Bank and has been a regular visiting lecturer at Harvard University and currently at Queen’s University. Author page: http://ssrn.com/author=262460.