Banks in recession-hit Cyprus, reeling from a financial crisis, are struggling with non-performing loans that make up nearly half their lending and are hampering efforts to finance a cash-starved economy.
The central bank says banks' liquidity is sufficient to absorb NPLs up to a certain point, but fast action is needed as the figure is rising.
So government, lenders and borrowers are seeking ways to reverse the trend without further damaging an economy forecast to contract by 8.7 percent in 2013 and another 3.9 percent this year.
The total of NPLs -- defined as loans more than three months in arrears or rescheduled several times -- was 23 billion euros ($31 billion) at the end of September, according to the latest central bank figures.
That is well in excess of GDP that stands at only 17 billion euros, and represents 42.3 percent of total lending.
Fiona Mullen, a director at research consultancy Sapienta Economics Ltd, said they could soon reach 50 percent, before stabilising later this year.
Central bank Governor Panicos Demetriades has bluntly declared that management of NPLs and restructuring of loans in general present "the biggest challenge facing the banking sector in Cyprus."
Traditionally, Cypriot banks have not had a culture of chasing down delinquent borrowers.
A big chunk of NPLs is owed by powerful Cypriot business groups -- not only developers but also commercial conglomerates -- who have been able to use creative accounting to avoid meeting their obligations
A source at the central bank has said six billion euros, or 26 percent of NPLs are owed by only 30 borrowers.
There is also the fact that, even if banks want to act, out-of-date legislation makes foreclosure a difficult and lengthy proposition.
Putting house in order without chaos
Constantinos Pittalis, head of investor relations at the country's biggest lender, Bank of Cyprus, laments that "it now takes up to seven to nine years to go through the courts and land registry to foreclose property."
Some clients are "trying to take advantage of the legislation, that is taking forever. Usually the most sophisticated borrowers, who have good advisors, are the ones who tend" to default strategically.
But with pressure mounting on defaulters and fears of a massive foreclosure, Pittalis says "that is beginning to change."
"Customers are already reacting... some are bringing back money to Cyprus to repay part of their loans... some may try to find additional investors in their company or to sell assets."
But it all must be carefully orchestrated, says Spyros Spyridonos, vice president of the Cyprus Borrowers Association.
"I strongly believe that both parties should seek alternative solutions avoiding massive foreclosures, which would result in economic chaos worse than what we are dealing with today."
A major concern is the huge number of small businesses and homeowners who are unable to service their loans because of the recession, with consumer spending having plunged and unemployment reaching a record high of nearly 18 percent.
And Mullen said this is complicated by the fact that many small business owners, unable to obtain credit by other means, have resorted to mortgaging their homes.
Cyprus is under pressure from the "troika" of international lenders that gave it a 10-billion-euro bailout last March, to adopt legislation that would ease the foreclosure process. And parliament is considering a bill that should be approved and take effect by year-end.
Under the bill, it would take 30 months to foreclose on a primary residence put up as collateral. All other assets could be called in after only 18 months.
Marios Clerides is CEO of the Cyprus Cooperative Central Bank, which manages the cooperative banks nationalised under the bailout deal. They hold six billion euros in NPLs, a large portion of which are mortgages.
"We did not have a policy of debt collection," he said. "A loan was seen as a very flexible arrangement, but we have been forced to put some order in our house and be stricter, while trying to keep our culture of more human banking to keep our customers."
Demetriades said “a distinction should be made... between those borrowers who are cooperative and willing to meet repayments in line with their financial capacity and those who are able to repay but are unwilling."