Cultivating a positive payment culture

Cyprus has made substantial progress in addressing its key risks in the crisis and continues to do so as significant vulnerabilities are still present.

Debt dynamics have turned positive and in the banking sector recent developments, such as those relating to the Cyprus Cooperative Bank and the sale of non-performing loans by Bank of Cyprus, have led to a steep reduction in the outstanding stock of non-performing loans.

Total Non-Performing Loans (NPLs) dropped from EUR 20.9 bln at the end of December 2017 to EUR 16.8 bln at the end of July and will drop further to under EUR 11 bln when the sale of the Cyprus Cooperative Bank is consolidated. The NPL ratio can be expected to drop towards 30% by the end of the year.

Non-performing loans and high private indebtedness are the two sides of the same coin. A reduction in the former leads also to a drop in the stock of private loans. The economy deleverages - a painful process that is.

There has also been another positive development summer. Parliament passed legislation for closing loopholes in our insolvency and foreclosure laws and facilitating the sale of non-performing loans.

This legislation entails the strong potential to make a significant contribution to the efforts for further reduction in non-performing loans.

It makes it harder for strategic defaulters and allows the government to design schemes like the Estia, which can help households who need help with their mortgages. this the for

The Estia scheme needs a careful structure so as to focus its intended support to those who really need it. I do not share the concerns expressed against it as allegedly a recapitalisation of banks, far from it.

Estia is a government-sponsored programme that has a social dimension and is an expression of solidarity in our society.

We went through a terrible crisis and many paid a very high price from it. It is a fact not fiction that a number of households are unable to make their due payments on their mortgages for their primary homes.

Eligible households, once the criteria on family income, wealth and value of the property are met, will benefit in the following way: The bank involved will reduce the principal by making incremental write-downs over time; it will also restructure the loans by cutting interest rates and by extending the length of the loan so that monthly repayments are reduced; the government will then subsidise those loan repayments. The alternative would be for those households to lose their homes.

Yes, the scheme will have a fiscal cost which the taxpayer will pay in the end but it a fiscal cost that is well expended in my view.

Moreover, when spread over the duration of the programme of 20-25 years, the annual fiscal expense is marginal. Moral hazard problems in the context of the reformed foreclosure and insolvency framework will be unlikely.

Arguments that a scheme like Estia rewards delinquent behaviour and that therefore good borrowers should be likewise rewarded is totally misplaced and if anything shows a total lack of understanding about how the banking system works. So, I will make a little digression here.

Banking intermediates between savers and lenders and the well-being of the economy depend on the efficiency and the effectiveness with which banks channel funds to their best uses.

Unless funds move from savers to investors through the banks the nation cannot grow its capital stock, it cannot increase productivity and, in the end, the economy stagnates and declines. Banking intermediation is an absolutely essential function.

But all banks are fragile. By the nature of their operations, banks lend their deposits which they owe to depositors. If banks were to keep these deposits in their vaults, they will have to charge interest for safekeeping not pay interest.

If they lend poorly, or if the payment culture in an economy is poor and the risk of not collecting their money is high, banks will not lend or will lend at high cost thus undercutting economic growth.

If banks cannot lend profitably the very idea of saving and depositing collapses and with it any prospect for a growing economy.

If confidence is lost, the payments system collapses and the economy grinds to a halt. That is to no one’s benefit or profit.

Banks need to have in place an effective framework that cultivates a positive payment culture, and the economy needs a properly regulated banking sector that forces it to do its job – preserving the payments system and with it a wellfunctioning economy. Yiannis Tirkides is Economic Research Manager at Bank of Cyprus