What happens if cyprus defaults

Enforcement of individual claims may take considerably longer in the wake of a financial crisis as the number of claims surges, institutional resources become stretched, while the rapidly-growing backlog of cases could potentially take years to clear. Scaling-up available resources to meet this peak in demand may not always be feasible given long lead times to train professionals. In addition, it may not be efficient to do so given the temporary nature of the claims increase and because some bottlenecks may be attributable to administrative procedures rather than resource availability.

Moreover, separate fast-track enforcement procedures may be warranted to discourage debtors from exploiting the slower enforcement by intentionally defaulting. This section reviews the literature on the economic implications of slow claims enforcement.

The focus is on links between weak enforcement and the credit market through economic and strategic default, and access to finance, as well as the implications of a crisis for enforcement capacity.

Weak claims enforcement can give rise to increased economic or involuntary default. Late-repayment of inter-company trade credits is found to be an important cause of involuntary default and business failure in the UK, especially among small and medium-sized firms Paul and Boden This is because when a firm is unable to secure payment from its customer, the resulting break in the chain of liquidity in turn prevents the firm from paying its suppliers, thereby triggering a liquidity-induced insolvency.

More generally, the European Commission finds that late payment negatively affects the liquidity of enterprises—especially small and medium-sized enterprises—complicating their cash-flow management and limiting access to finance, often leading to bankruptcy, job losses and stifling entrepreneurship European Commission, Strategic or voluntary default on a mortgage loan can be considered as the exercise of a put option by the borrower.

The latter, in turn, depends on the legal framework for foreclosure and the pace at which foreclosures can be processed. These factors become especially relevant during periods with high foreclosure rates when judicial and administrative resources are likely to be stretched.

As discussed below, these predictions are generally borne out in the empirical literature. In contrast to an economic defaulter, a strategic defaulter has the financial means to service his debt but finds it in his personal interest not to abide by the credit contract.

Jappelli, Pagano and Bianco develop a theoretical model of opportunistic borrowers and inefficient courts, whereby a solvent borrower may be unwilling to repay if the gain from defaulting exceeds the perceived cost of presumed sanctions. In turn, sanctions are a function of judicial efficiency, which determines how much collateral the lender can expect to recover from a defaulting borrower.

An implication of their model is that poor judicial enforcement increases opportunistic behavior by borrowers who anticipate the high cost that creditors face to recover loans, thus tempting borrowers to default.

These predictions are confirmed by cross-country experiences. The incidence of default on a mortgage loan is found to increase as borrowers are more underwater in terms of negative equity in the home Gerardi and others and Bajari, Chu and Park In the US, the prospect of having to relinquish housing collateral is found to be a critical factor in deciding whether to default, with weak claims enforcement tilting the balance toward voluntary default by reducing the likelihood the borrower will face any enforcement action Guiso, Sapienza and Zingales Also in the US, expected delays in foreclosure are associated with increased rates of mortgage default among underwater homeowners as defaulting homeowners can live in their home rent-free until the foreclosure process is complete Chan, Haughwout, Hayashi and van der Klaauw The longer the expected rent-free period, the greater is the incentive to default.

A higher incidence of strategic default is generally found with nonrecourse mortgages. However, this assumes that borrowers know the legal basis of their mortgage. Similarly, Ghent and Kudlyak find that recourse reduces mortgage default for underwater homeowners, especially those with higher-value properties.

Consistent with their first hypothesis, they find that survey responses regarding the subjective probability that a bank would pursue a defaulted borrower does not to differ between recourse and no-recourse states. Initiatives introduced for social reasons may generate perverse outcomes. A moratorium on foreclosure and repossession can be considered an extreme form of lax enforcement. Using data from a large Greek bank, Artavanis and Spyridopoulos analyze the effect on mortgage loan performance of a law that places a moratorium on foreclosure of primary residences.

They focus on borrowers eligible for both the moratorium and a separate debt discharge process for overly-indebted borrowers, which protects primary residences from liquidation but requires the borrower to disclose his true financial situation and subjects any other assets to liquidation. Strategic defaulters are defined as those who are delinquent on their mortgage but choose not to apply for debt relief under the debt discharge process, on the presumption that they wish to avoid disclosing hidden assets or income.

Liquidity or economic defaulters are defined as those who apply for debt relief after defaulting. The authors find that nearly 30 percent of defaults on primary home mortgages in Greece are strategic. They also find that while less-privileged borrowers are more likely to default, they are less likely to be strategic, with opposite findings among higher-income or better educated borrowers. Finance and legal professionals have the highest propensity for strategic default, consistent with their better understanding of the economic and legal aspects of the moratorium.

Similarly, Mayer and others find that a prospective change in policy in the US, whereby seriously-delinquent borrowers would be offered mortgage modifications, caused homeowners to strategically default. The largest increase in default rates was observed among borrowers in better economic positions. Individual borrowers are found to default selectively across different forms of debt. For the US, Chan, Haughwout, Hayashi and van der Klaauw find that declines in home equity are associated with a lower probability of default on credit card and auto loans.

This suggests that homeowners make strategic decisions to preserve access to other credit lines in anticipation of defaulting on their mortgage, with the resulting loss of credit secured by their home. Borrowers are also found to act strategically toward weaker banks.

Specifically, recognizing that a good track record on loan repayments is only valuable if the bank survives and can issue new loans, borrowers tend to discriminate against weaker banks by selectively defaulting against those banks. However, the likelihood that a bank survives depends on whether other borrowers repay their claims, resulting in an externality that can lead to coordination failure and a borrower run Bond and Rai and Trautmann and Vlahu In Italy, where many firms borrow from multiple banks, firms are found to selectively delay repayments to those banks already weakened by past bad loans Schiantareli, Stacchini and Strahan Moreover, they find that the tendency to delay payments to distressed banks occurs in regions where legal enforcement is weaker and recovery times are longer.

As many of these loans become permanently impaired, banks then become caught in a vicious cycle of past distress that encourages future losses. Unlike economic default, strategic default is found to be contagious and is spread through social networks. Exposure to other people who have strategically defaulted is found to increase the propensity that the individual will also strategically default.

For the US, Guiso, Sapienza and Zingales find evidence that social contagion is the result of learning, whereby knowing someone who has strategically defaulted reduces the perceived probability that a bank will pursue a defaulting borrower.

Media coverage of strategic defaults may have also played a role. In their empirical study on Greece, Artavanis and Spyridopoulos find that relocating from an area with low- to high-incidence of strategic default is a strong predictor of strategic default within the next year. In contrast, economic default—while found to cluster, likely reflecting localized economic weakness—is not found to propagate. Additional evidence of the influence of claims enforcement on strategic default behavior is obtained from research on the effect of strengthening enforcement.

On the other hand, excessively-strict enforcement may have adverse effects by sweeping up both economic—and strategic—defaulters. Olney finds that highly-indebted US households in sought to avoid default on consumer loans used to finance purchases of appliances and cars because, under the punitive laws at that time, repossession would have wiped out any accumulated equity.

A change in the law in required return to the borrower of any acquired equity, thereby making default less costly. As a result, later recessions saw higher household default rates, while other borrowers rescheduled their loans, both of which helped to limit the severity of the downturn. Borrowing costs are generally found to increase in the presence of ineffective enforcement. Based on cross-country data, Bae and Goyal find that stronger enforceability of contracts is associated with lower interest rate spreads.

They also find that during the —98 Asian financial crisis, loan spreads widened more in countries with poor enforceability of contracts.

Laeven and Majnoni find that judicial efficiency is a major driver of interest rate spreads across countries. The volume of loans outstanding is inversely associated with weak enforcement and judicial inefficiency.

Levine finds that legal rights of creditors and the effectiveness of enforcement explain over half the cross-country variation in loans outstanding as a ratio to GDP.

For India, Chemin documents causality from slow judicial speed to reduced access to credit, ultimately leading to lower output. Based on panel data on Italian provinces, Bianco, Jappelli and Pagano find that where the backlog of pending legal trials is relatively long, credit is less widely available, average interest rates are lower which they attribute to only low-risk borrowers being able to access credit , and the default rate is higher.

During a financial crisis, increased defaults create bottlenecks in formal enforcement that can generate benefits, but also opportunities for borrowers to exploit. Herkenhoff and Ohanian find that the temporary lengthening of time to foreclose in the US had the unintended, positive consequence of allowing unemployed homeowners time to find a well-paying job that provided them the income to become current on their mortgage, allowing them to remain in their home, rather than losing it to foreclosure, with positive effects on the macroeconomy.

On the other hand, Drozd and Serrano-Padial document that the wave of defaults in the US during the global financial crisis GFC significantly lengthened foreclosure times, and delayed the threat of eviction by up to three years. The implicit transfer that borrowers receive as a result of the foreclosure delay incentivized others to default. They construct a theoretical model where contract enforceability is endogenous to the state of the economy.

Specifically, borrowers know that when the ex-ante fixed enforcement capacity is fully utilized, additional defaults weaken enforceability, thereby strengthening incentives to default. Similarly, Chan, Haughwout, Hayashi and van der Klaauw document that expected delays in the foreclosure process are associated with increased rates of primary mortgage default among US underwater homeowners.

This literature points to several recommendations for avoiding or responding to enforcement constraints. Drozd and Serrano-Padial propose to reduce the adverse effects on aggregate credit supply of overburdened enforcement systems by attempting to prevent more default-prone borrowers from defaulting in the first place, thereby mitigating the snowball effect of clustered defaults. They provide as an example the US Home Affordable Modification Program, which targeted underwater but not yet defaulted households.

Herkenhoff and Ohanian propose allowing unemployed-and-defaulting homeowners additional time before foreclosure to allow them to find a well-paying job that matches their skills. Some degree of centralized coordination is likely to be most efficient when responding to a systemic crisis.

Pursuing a case-by-case approach would overwhelm courts and could also lead to coordination failures and externalities that impede debt restructuring Laryea The appropriate strategy should weigh the costs of a centralized scheme against the inefficiencies from the potential grid-lock created when the number of defaults is much larger than the institutional capacity can handle. Laryea also suggests establishing incentives through law to catalyze out-of-court restructurings and allow a qualified majority of creditors to be able to bind a dissenting minority to a restructuring agreement.

Grigorian and Raei document that many crisis countries reformed or amended the law to facilitate post-crisis restructuring. In particular, Spain amended the insolvency law with the aim of eliminating legal uncertainty in out-of-court restructurings.

Claims enforcement in Cyprus is considerably less efficient than in most European Union EU countries. The banking crisis, which led to a spike in the number of pending litigious civil and commercial cases, could be a factor in the low enforcement efficiency. According to the EU Justice Scoreboard, the number of pending cases rose by 50 percent from four to six per one hundred inhabitants between and This was among the sharpest increase and highest levels within the EU.

In other countries that experienced banking stress, the number of pending cases quickly fell back. For Cyprus, while data beyond the onset of the crisis is not available, anecdotal evidence indicates that the number of pending court cases has risen further. Although incoming cases did rise, the major factor in the high and growing backlog of court cases appears to be the low, and declining, clearance rate. At around 80 percent, the ratio of resolved court cases to incoming cases is well-below the percent needed to prevent the backlog of cases from expanding.

As discussed below, ineffective enforcement of commercial claims reflects mostly structural—rather than cyclical—factors. The main legislation on civil procedure is outdated. It dates to the colonial period, with some elements going back to the mid th century. These rules stipulate entirely paper-based in-court processes, with hand-written ledgers for record keeping and each page of documentary evidence hand-signed by the court clerk. Interim applications are used extensively and cause major delays.

Both debtors and lawyers given their fee structures have incentives to file multiple applications in order to encourage delays. As a result, interim applications and appeals can lead to exponential growth in the number of system-wide cases, causing protracted delays. Expedited enforcement of small claims is rarely used.

However, this process is subject to interim applications, thereby causing the expedited procedure to revert to a regular court procedure. Moreover, the court system operates on a first-come-first served basis, and must therefore first resolve the large number of pending cases filed under the old regime before beginning to hear small claim cases under the expedited procedures.

At the current pace, the first case is not expected to be heard prior to Enforcing a court decision is cumbersome and a source of further delay. A decision by the court does not provide full title to enforce, and the creditor must return to court to secure a separate court order for each individual enforcement action e. Further, these applications may be appealed by the debtor, thereby generating their own secondary litigation.

Salary and deposit garnishment systems are weak, further undermining claims enforcement. Cross-country experience indicates that commercial claims in advanced economies are largely recovered through garnishments.

The legal framework for garnishment exists in Cyprus, but is cumbersome and ineffective. Public information infrastructure is not supportive of claims enforcement. The land registry is cumbersome to search. Moreover, it is not possible to search the registry for the name of close relatives e. The register of companies can only be searched by the company name, making it impossible to discover all the companies in which a debtor owns shares.

Alternative means of dispute resolution ADR that take place outside the court system, notably mediation, remain under-utilized. Cyprus enacted a mediation law in It often indicates a user profile. Log out. US Markets Loading H M S In the news. Markets Contributors. Michele Kambas , Reuters. Sign up for notifications from Insider! Stay up to date with what you want to know.

Loading Something is loading. Email address. Deal icon An icon in the shape of a lightning bolt. Reuters Top News. According to Michael Sarris, who would become finance minister for a short period after early elections, talks between Cyprus and what was then the troika of aid institutions focused on small issues instead of how to move forward.

An agreement on conditions seemed close in November , by which time the ESM was up and running. Juncker, then the outgoing president of the Eurogroup, said in early December that Cyprus was already taking the first steps to implement the draft agreement and he looked forward to its conclusion soon [4].

But by January , talks had stalled. At its last meeting under Juncker, the Eurogroup announced that the programme would be delayed [5]. When euro area finance ministers met on 4 March , an accord appeared within reach. That deadline would be met, but not in the way the Eurogroup envisaged. What made Cyprus different from previous programme countries was the size and skewed nature of its financial sector. The state aid was necessary because the bank had fallen short of meeting its minimum regulatory capital requirements as determined by the European Banking Authority, which in had started stress-testing banks across the EU.

The problems ran deeper than the banks. In other words, Cyprus was seen as potentially systemic, bearing a risk of spillovers to the rest of the euro area. This tangle of fiscal, financial, and economic deficiencies formed the backdrop for the last act in talks that would make Cyprus the fifth euro member state to receive emergency assistance.

The IMF and several northern European countries pressed Cyprus to bail in bank creditors, Sarris said, to ensure that investors, debt holders — and ultimately depositors, because of the way the banks were structured — would absorb a share of the losses to cover the capital shortfall. Meanwhile, Cyprus was running out of time. Following its internal rules, the ECB was poised to cut off the Cypriot banks from their last lifeline, Eurosystem emergency liquidity assistance. Matters came to a head at a Eurogroup meeting on 15 March With the ECB threatening to withdraw the emergency liquidity, Cyprus was faced with the choice of applying for a programme or abandoning the euro.

Our emails are made to shine in your inbox, with something fresh every morning, afternoon, and weekend. But because Cyprus is widely considered an offshore tax haven for the Russian wealthy, European policymakers are unwilling to bail them out. They should really reconsider that assessment, however. Although they may hold significant Russian deposits, a deeper dive shows that Cypriot banks really look a lot more like Greek banks, a few hundred miles across the Mediterranean.

Sovereigns in Europe still depend on domestic banks to fund them even when the banks are in trouble. It worked.