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We hear a lot about how the new law regarding the packaging and selling of bank loans will finally help in dealing with the enormous problem of non-performing loans in Cyprus. I like to keep an open mind even when it is rather hard to identify how and from where the added value will come.

What do we know for sure?
The loans, mainly non-performing but not only, will be sold at huge discounts. Some experts go as far as predicting that the price to various funds and other anxious takers will be even below the amount provided for by the banks.

That in itself is very alarming as this will inevitably create further losses which will need to be covered by new capital. But the huge paranoia is with regard to the general belief, put forward by some politicians in particular, which suggests that if only we could somehow sell off the non-performing loans we will also get rid of the problem.

What they fail of course to point out is that loans (whether non-performing or not) are assets that the banks hold and which secure the repayment of deposits and other obligations they have. It is not serving anyone, least of all the tax payers, who will inevitably be called on to recapitalise a failed bank, to allow the current shareholders of our banks to sell off these assets at will and without regulating the price so as to ensure maximisation of value for the bank.

The other huge misconception is with regard to how people tend to look at non-performing loans (NPLs).

Politicians and “experts” such as the troika or even credit rating agencies keep referring to the mounting NPLs in Cyprus banks as the cause of our economic predicament. NPLs are nothing more than a symptom. The real problem is a choked economy mainly because of a massive private debt which emerged following many years of granting bad loans based on collateral and security considerations rather than a proper assessment of repayment capability.

These loans were levied by the Cyprus banks on the shoulders of unsuspecting, or at the very least, blissfully ignorant customers. The end result was that the equity base of most business enterprises was eradicated and consumer demand stifled, factors which are not conducive to new capital investment that the country now badly needs.

To be fair to the banks, they were not the only culprits. The Central Bank of Cyprus (CBC) was at best neutral if not actually encouraging, rather than controlling and managing, the inflow of deposits into Cyprus. It also failed to identify the risks and to regulate the huge (by our standards) expansion of our banks into unknown territories abroad.

The legislators also are up there in the list of culprits as they have facilitated legislation which encouraged rather than contained the uncontrollable money expansion from abroad. Other than the bankers themselves, some lawyers and accountants also have a primary share of the blame as they pursued their own and their clients’ very narrow interests irrespective of the collateral damage they were inflicting on the economy.

A number of lawyers and accountants, who went by the popular name tag of “introducers”, were instrumental in establishing and maintaining a “corrupt”, but thanks to the absent and pathetic stance of CBC, a largely legal system of funding inefficiency and waste in the grass roots of the Cyprus economy.

Pretending that the problem is the symptom is not helpful in finding a solution. Even if one puts aside the “who is to blame” game, facts are facts:

Fact 1, the economy is struggling.

Fact 2, our businesses have no real net worth since they owe all they have (and sometimes more) to the banks.

Fact 3, many of these businesses have invested the enormous flow of loan funds coming towards them so easily from the banks into land and unproductive uses.

Fact 4, there is a very weak and feeble demand for goods and services which impedes viability of existing and new businesses.

What are the possible solutions then? For a start, pretending that throwing more loan funds into the economy will help is an illusion. The banks already have excess liquidity. What they don’t seem to able to come up with are viable financing proposals. It is this that we need to solve in order to get the economy started again.

Why then is it so hard to find viable projects in Cyprus since the bail-in? The simple answer is that the economic agents (both at the corporate and the household level) are drowned in debt with hardly any savings to fall back on.

One may very well ask, but why is this so, since the “deposits by locals” in Cyprus banks are reported to be very high? The answer is simply that despite the fact that they are presented as local deposits, these in truth are mostly foreign owned. Since 2011 the deposits by Cyprus companies which are foreign owned are considered for statistical purposes as local. Moreover, these foreign owned companies, if not just vehicles of convenience and therefore dormant, hardly conduct any of their business activities in Cyprus. And that reveals the true magnitude of the mismatch between the loans held by the banks as assets which are almost exclusively weighing on Cypriots and the deposits which are predominantly foreign owned.

Another aspect of this unstable foundation of our banks is that the deposits are solid and “cast in stone” while the assets (loans mainly) are toxic and are deteriorating by the day. This is a very unhealthy base on which to build and grow the economy from. An investor, whether local or foreign, will have to consider the country risk emanating from such unsteady economic foundation.

This is not a problem that can be easily fixed. And yet, it is one that our government has brushed aside. Possibly on the wrong advice by special interest groups, the government has rushed into a campaign to attract new capital investment to Cyprus, ignoring the fundamentals of our situation and wishfully thinking that potential investors will follow suit. But the truth is that no potential capital investor worth having will be one who does not carefully study and takes into consideration the risks involved. To be over eager to attract foreign investment by lowering the hurdle and in essence to be willing to “bribe” potential investors to do a project that is less than average is not the way that a prudent government pursues economic development.

We have to get serious in order for others to take us seriously. Sound investments are not undertaken over a drink or through government PR events. It reminds me of the pathetic attempts by President Christofias to close a deal for a non-viable hotel and resort project next to the Hilton in Nicosia. Another tragic example we are still living through is the natural gas investment scenarios put up and changed every few months by the government.

Where does it end? When will we finally get our house in order and try to understand what our options are and what is really at stake before we start talking to others about it? As Theodore Levitt wrote in his classic paper “Marketing Myopia” (paraphrasing from Lewis Carroll’s Alice in Wonderland) “if you don’t know where you are going, any road takes you there“. Perhaps our government intentionally or unintentionally prefers such vagueness and ambiguity rather than being confined to pursuing what is right and then to be held accountable if it fails to achieve it.

Which brings me to the main problem bugging the Cyprus economy, which in project finance terms is called “market risk”. As mentioned above, economic agents in Cyprus (corporate and individuals) suffer from the same over-borrowing syndrome. This manifests itself in under-capitalised enterprises and a feeble demand in the local market for most goods and services other than perhaps necessities such as food, beverages and medicine. Any new capital investment, whether from home or abroad, has to have a healthy supporting infrastructure of products and services which will enable it to be competitive but even more importantly a strong and sustained demand for its products or services.

The latter is probably a much bigger obstacle to potential viability and therefore a deterrent to new investment. There is however a possible way out of the low demand trap by focusing first and foremost on tourism and export oriented projects. This will likely generate demand that spills over to local businesses, ones that provide supporting products and services, and will also increase local income through employment which will improve demand in general.

But in order to boost the supply of tourism related projects and others which do not primarily rely on local demand it is necessary to address the private debt problem which is suffocating the industry and also manifests itself as the bulk of the non-performing loans in our banks.

To this effect, I have been proposing, for two and half years now, the creation by the government of a special Development and Investment Bank (DIB) to deal with the need to restructure big projects in distress and to foster and accelerate the pace of economic development. The DIB will provide for the need to have equity and quasi-equity instruments in place to support the need to replenish the depleted equity capital base of potentially viable businesses. The new institution would be manned by experts from Europe and Cyprus in project finance solutions and would assist commercial banks and their existing customers to reach amicable and economically viable solutions in newly formed special purpose companies.

It will probably be necessary to also create National Asset Management Company to hold and manage the bank assets which cannot be done within a bank. This company would manage the assets and the recovery process as well as to act as a repository of components (building blocks) which the DIB would use to put together new viable  special purpose vehicles to be spun back into the economy with a strong equity base and with a manageable debt to carry.

Why has not a major repair job at the core of our ailing economy happened yet? The truth is that the government is more concerned with the shop window rather than the shop itself. It is building up fake hopes by projecting false expectations, such as the quick exit from the memorandum of understanding with the troika and/or the return to government borrowing from the markets as indicators of their own success. And because politicians in Cyprus have a long history of not caring to go beyond what they think they can get away with, once again, they choose the easy route out.

Pursuing the substance is at best a secondary objective which is only adopted if it comes at zero cost and most importantly does not put in doubt the “economic miracle” fantasy they are building up towards. In all my attempts to push for these ideas with the government, we always hit a brick wall when it comes down to their willingness to fund these initiatives. The saddest thing is that it seems to me that the main reason the government did not buy into these proposals was not because they were not convinced that they would work, but rather because it is rather unlikely for such ventures to bear fruit soon enough for a political gain, and the cost of funding them may derail the accomplishment of their pseudo aims which will help them claim economic success with the voters. Déjà vu!

By Savvakis C Savvides

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 more recently at Queen’s University, Canada.