The Characteristics of Strategic Default on Bank Loans

JAN-FEB 2018|BY PANAGIOTIS K. AVRAMIDIS, ASSISTANT PROFESSOR OF FINANCE, ALBA, THE AMERICAN COLLEGE OF GREECE
Non-performing loans represent the biggest source of uncertainty for the Greek economy and the domestic banking system. The prolonged economic recession has negatively affected household income, rendering Greeks unable to meet their bank obligations.

In response, banks rightly assumed some responsibility by offering financial relief to these households in the form of loan restructures. However, among the bank loan defaulters, there is a minority of borrowers who have the financial ability to pay back their liabilities but choose not to do so. This group of strategic defaulters, as they are known, has emerged due to loopholes in the legal system and the decline of the social stigma that such behaviors used to have in earlier eras.

In a recent study, participants in ALBA’s MBA in Financial Services1 studied the views and incentives of strategic defaulters in an attempt to shed some light on the characteristics of this special group of borrowers. They surveyed 396 individuals and found that 26% had some bank obligation in arrears. From this pool of defaulters, 19% were identified as strategic defaulters based on a combination of quantitative and qualitative characteristics. The team then compared the responses given by strategic defaulters and by non-strategic (genuine) defaulters. The findings of this analysis were revealing.

First, the majority of strategic defaulters (52.6%) are unaware of the loan restructuring solutions offered by banks. This proportion is substantially higher than the equivalent percentage for non-strategic defaulters (18.1%). Similarly, 72.7% of strategic defaulters find existing loan restructuring programs insufficient; that is twice the percentage of non-strategic defaulters (36.1%).

Furthermore, almost all strategic defaulters believe that banks take the risk of borrower insolvency when they lend money, and therefore their decision not to pay back the loans does not constitute a breach of contract. Instead, they see this as the bank’s business risk.

Regarding the sale of non-performing loans to funds, half of strategic defaulters responded that they would be less inclined to repay the loan if the bank sold it to a third party. In contrast, only 14.1% of non-strategic defaulters replied that the sale of the loan to a fund would affect their willingness to pay back.

Finally, the demographic characteristics of strategic defaulters show that they are mostly male (84.2%), aged over 46 years old (68.4%), and university educated (42.1%). Unsurprisingly, they also consider themselves risk-takers (57.1%).

Summing up the study’s findings, we observe that strategic defaulters are reluctant to take up their responsibilities and are less cooperative with the banks compared to the non-strategic defaulters. Consequently, banks should treat the two categories of borrowers differently if they want to reduce the stock of non-performing loans. Specifically, banks should offer restructuring programs that cover the needs of non-strategic defaulters in order to limit the social cost of the crisis and help these households to recover quickly and avoid becoming marginalized. In contrast, banks should display strong determination and take the appropriate legal actions against strategic defaulters. By doing so, they send the right signal to current and to future borrowers: There can be no free lunch without consequences.

1 Petsakos A., P. Moumou, M. Domouliaka and Ch. Dat

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