What Lies Beneath? Truth And Lies About The Cyprus Economy

Savvakis C. Savvides

Cyprus Development Bank – Project Financing Division

December 1, 2015

Accountancy Cyprus, Vol. 121, December 2015


Following the extra ordinary decision to bail in the unsecured depositors and restructure the two main banks and the near complete destruction of the country’s economic business model as an International Financial Centre, the author considers the real causes of the problems facing the Cyprus Economy and the reluctance of the Government to take firm action to put back the country on a development path. Cyprus must rebuild its economy on solid and sustainable foundations. The effort should revolve around the need to build a capability to source funds and appraise capital investment projects, and to take the initiative so as to create a National Development Finance Agency in Cyprus to undertake the lead in appraisal and financing of key developmental projects and Public-Private Partnerships.

Note: The article was published in the Accountancy Cyprus Journal, Dec. 2015, No.121 and the Cyprus Mail as well as the Stockwatch blog in October 2015.

What Lies Beneath? Truth And Lies About The Cyprus Economy – Introduction

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 nonperforming 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 from. 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 that is 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 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 the problem for 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 and also failed to identify the risks and to regulate the huge by the standards of a small island economy 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.

With the above situation analysis 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 one 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

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