Cut interest rates, write debt off.

December 07 2013

By: Dr.George Mountis

VARIOUS bankers have come out against cutting lending interest rates and in favour of extending the loan repayment period. The reason is simple: an interest rate reduction of around 3 percent on the overall loan portfolio of Cypriot banks would entail an annual drop in interest payments by borrowers of some €1.74bn (or 3 percent of €58bn).

Falling revenues from interest (including interest on late payments) would seriously deplete banks’ profits as well as their capital base. These losses may therefore necessitate a new haircut, the bankers argue. Fair enough. But could it be that all these ‘massive’ revenues from the interest (which incidentally happens to be the highest in Europe) are in fact illusory, given that most borrowers today cannot (nor will they ever be able to) service their interest payments? Incidentally, no mention is made here of paying down the principal. One can conclude therefore that we are living in a sort of banking dreamland, and important decisions need to be made to correct the problem.

The current ‘recession’ in Cyprus is the outcome of the havoc wreaked upon society and the economy following the recapitalization of domestic banks via the ‘bail-in’, or haircut on deposits. Other reasons are the reckless over-lending to households and businesses, excessive public debt and deficits and so forth.

Thus the government as well as the ‘recapitalized’ domestic banks must realize that, in order for the economy to grow on a solid foundation, household and business debt should be immediately – and significantly- reduced. Interest on late payments and charges on delinquent loans should be written off immediately, including capital interest which borrowers will never be able to pay off mainly because of prior exorbitant extortionate charges levied by domestic banks.

Just days ago, and six years after its banks went bankrupt, Iceland went ahead with a debt write-off for households, targeting mortgage debt in particular. The write-off of €25,000 per mortgage will directly benefit around 85 per cent of households. Moreover, whereas in Cyprus deposit rates have been seriously scaled back – though they began rising a little this month – current as well as new lending rates remain sky-high instead of being slashed by a corresponding amount (or even perhaps more than that). The slight reductions in lending rates recently announced – a public relations stunt more than anything else – are not sufficient.

In order for the economy to reboot, businesses need access to cheap credit. The Cyprus government must take a close look at the excessive household and business debt, and urgently raise the issue of possible debt write-offs, obviously under certain conditions and restrictions.