11 Mar 2018 Can a Cyprus solution fix the bank NPL problem?

This is the English version the article published in Greek in Politis on Sunday 11 March 2018. 

If you read between the lines of what Danièle Nouy, the Chair of the Supervisory Board of the European Central Bank (ECB), said during her visit in February, the banks have only a short period in which to take major steps to fix their €21 billion problem with non-performing loans (NPLs).

The European Commission is currently examining the proposed ESTIA programme, that is designed to help pay off some of the loans, but it is not yet clear if it will pass state aid rules. Even if it does, it is expected to handle only €1 billion of bad loans. Other drastic measures will need to be taken. Fears about what those might entail have already led to a small bank run in January.

Yet there might be a simple solution to the NPL problem that would relieve borrowers of their bad debts without killing bank balance sheets. It lies in a federal settlement of the Cyprus problem. Below I explain how it might work.

There are currently around 188,000 hectares of private Greek Cypriot property in northern Cyprus and approximately 330,000 hectares of Greek Cypriot private property in the south (plus another 52,000 hectares of Turkish Cypriot private property). In 2012, the Land Registry valued the Greek Cypriot private property in the south for tax purposes at €150 billion. From this figure, we can infer that the medium- to long-term value of Greek Cypriot property in the north (meaning after it is operating in a normal market) is €85 billion. Earlier studies by the University of Cyprus put the value, based on a different methodology, at €65bn for the period 2009-11.

In the latest round of negotiations, there were hints that the property settlement will be carried out on the basis of the “one-third” rule: one-third reinstated, one-third exchanged for Turkish Cypriot property in the south or for alternative property, and one-third compensated.

This means that, with a federal settlement of the Cyprus problem, Greek Cypriots will be getting back, either directly via reinstatement, or indirectly via exchange, around 125,000 hectares. Inferring from the Land Registration valuations above, there will suddenly be around €55 billion in property collateral that did not exist before.


Up to €23 billion in available assets

How much of this €55 billion will be held by borrowers in arrears? The banks probably have this answer, but as a rough guide, I refer to two statistics. First, research carried out by Djordje Stefanovic (Saint Mary’s University, Canada), Charis Psaltis (University of Cyprus) and Neophytos Loizides (University of Kent) in 2016 showed that, while 19.8% of the adult population had been personally displaced in 1974, a much larger proportion of 51.52% had been either “displaced themselves or through origin or through property ownership”. In other words, half of all adults probably have property in the north. The second statistic is that 52% of all households have bad debts. So at a rough guess, maybe around half of the property that will be returning, or around €23 billion, is owned by borrowers in arrears. This amount is already larger than the total NPLs in the banking system.

Borrowers in trouble could be offered the option of using some of that property to conduct what is termed “debt-for-asset swaps”—just as many large companies have recently been doing. Alternatively, since borrowers would now have a larger stock of assets (property), they could keep the land that has been returned to them and swap other property instead. Whichever way it works, it will be important that refugees with bad debts have a choice. If they are forced to surrender their dispossessed property as soon as they have received it, then no one will vote in favour of a settlement in a referendum.

A lot more detailed work is needed by experts in real estate, asset management and banking to see if this could really work in practice and whether the valuations I cite are realistic. However, even if the valuations are half as much as my very rough estimate, it is still more than €10 billion. That is an awful lot of assets that could plug a massive hole in the €21 billion NPLs.

Moreover, since the solution of the bank problem comes with a solution of the Cyprus problem, it will also be a great deal better for our international reputation than the other “quick fix” we have been using. The “golden passports” scheme might have helped the banks and highly indebted developers in the short term, but it has spawned almost weekly articles in the international media claiming that Cyprus is handing out thousands of passports to the global mafia.


Only with a federal solution

It is also important to note that the property option for banks would not exist in case of a two-state solution.

We know this because, in 2017, Turkey’s President Erdogan put forward a suggestion for a two-state solution, in which he said that Morphou and Kokkina could be “joined” and left to the Turkish Cypriots, while Famagusta, including Varosha, could be left to the Greek Cypriots. In other words, refugees would not be able to return to Morphou, and even Varosha would not come “for free”.

If we are tempted to dismiss Mr Erdogan’s suggestion as a one-off remark, it is worth remembering that Turkey tends to signal long in advance what its intentions are. For example, it has been indicating its plans for the EEZ through statements of the Ministry of Foreign Affairs since 2011. Syrian experts had also been warning for some time about the inevitable clash between the US and Turkey over Kurdish fighters.

Under a two-state solution, therefore, banks would have to find other, more painful ways to settle their bad debts. Meanwhile, refugees would have no option but to go to the Immovable Property Commission (IPC), which for the time being is still sanctioned by the European Court of Human Rights.

However, the IPC moves extremely slowly. To date, it has awarded compensation for only 1.7% of the land area owned by Greek Cypriots and actually paid out compensation for even less. Even at its most productive pace (the year 2015), I calculate that the IPC would take 400 years to settle all cases. That is not a solution anyone can want.

By Fiona Mullen, Director, Sapienta Economics Ltd