Hellenic-Dutch Association of Commerce & Industry

Member: Society Premium
Since: 27.02.2014

18, Nikolaou Zekakou Street & K. Karamanli, GR-151 25 Marousi, Greece

RSS

The Road to Recovery: Are Greek banks able to finance Greece’s economic recovery?

20.10.2016 Share

[Market access for the Greek banks depends on external factors not directly controlled by the banks themselves1.]

By Nikolaos Karamouzis*

1. Introduction

The question dominating the public dialogue in Greece these days is whether the conditions are in place for the economy to return to a path of strong and sustainable economic growth. A year after the country signed its third Adjust¬ment Programme with European partners, many wonder whether the steady and timely implementation of the reforms and fiscal con¬solidation measures contained in the agreement alone is enough to ensure that happening, or additional initiatives are necessary.

For an economy plagued by a multi-year, dou¬ble-dip recession, record unemployment, ane-mic investment and high public debt, a return to growth should be the main priority of economic policy, the targeted cure for the economic ma¬laise. Just as importantly, it is a key prerequisite for the program’s success.

However, the road to recovery hinges on sev¬eral critical pre-conditions being met. Perhaps the most important of all is the ability of Greek banks to provide the credit needed to support economic growth. Will Greek banks have the financial strength, liquidity, capital and risk appe¬tite to finance the recovery cycle of the Greek economy?

The answer depends on how Greece - and the Greek banks - navigate five key challenges ahead. Namely:

• Restoring normal liquidity conditions.

• Successfully managing a large stock of bad and problematic loans.

• Diminishing official sector interference in bank¬ing operations.

• Tackling the sweeping, transformational chan-ges now gripping the European banking sector as a whole.

• Restoring positive Credit demand growth.

These challenges critically affect the ability of the Greek banks to deliver sustainable profitability and grow their business, but also seriously com¬plicate strategic decisions, priorities, operating and business models and risk management. This article aims to offer comprehensive answers to those questions, thereby assessing the current shape of Greek banks and, consequently, their ability to fund growth in the immediate and longer-term future; it concludes with policy sug¬gestions.

2. A creditless recovery?

All international organizations, including the In¬ternational Monetary Fund, are currently fore-casting a resumption of economic growth in Greece from 2017 onwards. Yet, credit expan-sion to the private sector remains in negative territory. According to the latest data available at the time of writing, bank lending (Including to the General Government) shrank at an an¬nual rate of 2.7% in July 2016, further extend¬ing a roughly five year-long downtrend. Lending to households and corporates in particular was even worse, shrinking at a 3.1% rate year-on-year in July 2016.

Credit demand depends on factors such as the level of GDP and rate of real economic growth, interest rate cost, economic climate and expec¬tations, inflation and the rate of unemployment. If bank lending proves weak, could financing for the recovery come from other sources? One could argue that the international capital mar¬kets could theoretically be an alternative source of funding for corporate and other economic entities. However, there are only a handful of major Greek companies and public utilities that have the required qualifications, size and credit rating today to borrow internationally, even as¬suming that global capital markets open up for Greek risk. Therefore, it seems that this is not a materially significant option for the future fund¬ing of the economy.

3. Coping with a liquidity squeeze

One of the biggest challenge facing Greek banks right now is the tight liquidity conditions. The liquidity squeeze mainly stems from the sub¬stantial funding gap between outstanding loans and deposits and the sluggish deposit recovery. The problem is compounded by the limited ac¬cess Greek banks have to the international capi¬tal markets. These twin problems have forced banks to become heavily dependent on the Eu¬rosystem - ECB and the Bank of Greece - for funding.

In my view, the return of Greek banks to the international debt markets is likely to proceed in tandem with the return of deposits to the Greek banking system. For that to happen, it is of paramount importance that the Greek gov¬ernment pursues a set of policies that improve Greece’s policy credibility, investment climate and market confidence. Since the beginning of the crisis, the Greek banking system has lost c. €124 bn of total deposits from their peak lev¬els – a staggering 45% decline. Relative to the size of the economy, that equates to ca 70% of current GDP, one of the worst global perfor¬mances ever.

Due to capital controls, as well as lingering eco¬nomic and political uncertainty, bank deposits have remained stagnant for months. However, during the second quarter of 2016 (April – July), there is some evidence of deposit repatriation into the banking system with ca €2.8 bn return¬ing, ca €1.8 bn from the Government and ca €1bn of corporate deposits. This is a positive development, especially if this trend continues in the following quarters.

Overall, the current liquidity conditions in the Greek banking system are as follows:

• As of July 2016, total deposits and bank re¬pos stood at €157.2 bn, against total loans at €222.4 bn. Thus, there is a funding gap of ap¬proximately €65 bn.

• Greek banks’ dependence on Eurosystem funding remains at very high levels, albeit re-duced from the 2015 peak at €78.5 bn in August 2016. Over the medium term, Greek banks are obliged to eliminate their ELA bor¬rowing, and reduce their total borrowing from the ECB to approximately €25 bn, based on current ECB rules.

• The total amount of banknotes in circulation in Greece (August 2016) remains at extreme¬ly high levels at €45.4 bn (equal to 27% of GDP vs a 9% average in the Eurozone). To put that in context, before the crisis, the average stock of banknotes in circulation in Greece was €20 bn.

• A large number of mid-sized and large cor¬porates transferred their cash reserves abroad before the imposition of capital controls last year. In addition, it is highly likely that they are not repatriating their proceeds from export activities. Total corporate deposits now stand at €15 bn compared to €38 bn before the crisis.

• Gross national income continues to shrink and gross national disposable income remains stag¬nant. Substantial additional tax charges recently imposed by the Greek government are mainly being funded through a draw down in savings, further reducing, ceteris paribus, the deposit base.

• Gross national savings have collapsed, drop¬ping in 2015 to 9.7% of GDP from a pre-crisis peak of 16.4%, and compared to an average of 23.2% in the Eurozone today. Household gross savings are currently negative (at -1% of GDP), compared to 4.8% before the crisis and a current average of 8.4% in the Eurozone.

• The maintenance of capital controls seriously hinder the process of orderly restoring sound liquidity conditions. Recent liberalization initia¬tives are in the right direction, however, the full lifting of capital controls will have to go hand by hand with the restoration of confi¬dence.

• Domestic credit expansion remains negative; the same is true for foreign capital inflows.

In my view, and based on my own estimates, if market confidence and policy credibility im-prove considerably and risk premia start declin¬ing rapidly, approximately €25 bn of deposits could return to the Greek banking system over an estimated period of 18-24 months. Altogeth¬er, that is more than one-third of the funding gap Greek banks need to cover. Therefore, we need ad¬ditional initiatives to further boost liquidity and restore sound local liquidity conditions.

It is worth noting that Greek banks’ access to international capital markets is gradually improving, at least for high qual¬ity collateral. Ultimately, market access for the Greek banks depends, to a great extent, on external factors not directly controlled by the banks themselves. It mainly hinges upon restoring market confidence, the credibility of economic poli¬cies and the Government’s commitment to reforms. In other words, it is a political issue rather than a commercial one. The government has to convince international markets that it intends to comply with Greece’s reform program, thereby providing the basis for a sustainable economic recovery, fiscal sustainability, financial stability, a complete lift of capital con¬trols, and promoting growth and investment. As long as the markets are not convinced, risk premia remain excessively high, especially because and Greece’s implementation track record is weak. In such a case, Greek banks will continue to face a liquidity challenge and, thus, will not be able to support investment and economic growth in Greece.

4. Managing the stock of bad loans

A second major challenge Greek banks are facing today is the efficient management and the orderly substantial reduc¬tion of the huge stock of non-performing loans. At roughly €115 bn at group level, based on the NPEs definition, they equal to more than half of the country’s GDP (EU aver¬age 5.7%). Reducing the NPEs stock hinges critically upon sustainable growth, job creation, declining risk premia and interest rates as well as full lifting of capital controls and re¬gained access to wholesale funding markets. There are no easy solutions to Greece’s huge NPEs problem. Greek banks should use all available tools and methods for viable restruc¬turing solutions, with a dynamic model of loss allocation, debt forgiveness and write offs.

The necessary ammunition is already in place. Greek banks have piled up a stock of more than €57 bn provisions against NPEs, while troubled loans are more than 60%-65% collat¬eralized, mainly with real estate assets. In addition, they run a healthy annual PPI of €4.3 bn (in 2015), which is a sizable capital buffer, along with strong capital positions, following three successful recapitalizations and stress test exercises. The challenge for Greek banks today is not capital adequacy but a strong management resolve. We need an effective NPE resolution process and we need it fast. Some important steps in the right direction have indeed been made recently. The Greek parliament passed landmark legislation that dra¬matically improves the legal and institutional framework for managing troubled loans. More needs to be done to im¬prove bankruptcy and pre-bankruptcy procedures, which remaining excessively time consuming and protecting mainly the interest of debtors. For the first time ever, Greek law provides for licensing loan servicers and/or the sale of per¬forming and non-performing loans to qualified third parties. However, in the areas of regulation and tax policy there is a need to facilitate the write-off of non-collectable loans, make effective use of the debt-to-equity conversion tool as well as reduce delays and the backload of cases in the judiciary, by expanding out-of-court settlements and creating specialized courts and judges.

The current situation frequently incentivizes otherwise sol¬vent individual borrowers and corporate shareholders to become strategic defaulters. Meanwhile, by keeping afloat non-viable companies, unfair market competition intensifies.

At the same time, performing companies should not be overburdened with higher interest rates in order to cover the cost of keeping afloat problematic, non-viable companies.

There is an urgent need for new tools and poli¬cies to deal with strategic defaulters, so as to allow banks to take over problematic compa¬nies more quickly, by removing managers and shareholders who refuse to cooperate by con¬tributing financially to restructuring or block oth¬er investors or creditors. Taxpayers and bank shareholders must not end up paying for the re¬structuring costs of indebted companies to the benefit of existing shareholders. The latter must pay the bill to stay involved.

Greek banks should make more active use of external NPL servicers - as Eurobank and Alpha Bank have done recently via their cooperation with KKR and EBRD -, sell selectively long dated NPL assets and examine with no prejudice the possibility of jointly establishing a “bad bank” with the HFSF and private investors. That ap¬plies especially for common, larger NPL corpo¬rate exposures.

5. Meddling in management

Greek banks had to agree on a restructuring plan with the European Commission’s competi¬tion authority and the Greek State. This includes reorganizing and downsizing of their operations, selling off mainly non-core and international as¬sets and complying with a number of constraints on management and staff. Collectively, these re¬strictions have seriously impeded Greek banks’ ability to effectively manage their balance sheets and grow their businesses.

Greek banks today are dependent on official sector support for their capital and liquidity needs in three main areas:

• The HFSF’s total holdings in the four banks, valued at current market prices, amount to €1.25 bn. The Fund’s direct equity stake in each of the four banks is as follows: Eurobank 2.54%, Alpha Bank 11.25%, Piraeus Bank 25.6% and National Bank of Greece 43%.

• The four banks have used Pillar II bonds (all in costs over 3%), via the ELA facility, to tap a combined €5.1 bn in system liquidity (August 2016 data - Eurobank: €2.0 billion, Alpha Bank: €3.1 bn, NBG: zero, Piraeus Bank: zero).

• Greek banks have issued perpetual preference shares bought by the Greek State, which will stop however counting as core capital from December 31st, 2017 and will at some point have to be repaid; Eurobank has €950 mn worth of preference shares outstanding, while NBG has converted them into equity in the last recapitalization. Piraeus Bank and Alpha Bank have fully repaid their preference shares.

Greek banks also face additional obligations in¬cluding:

• Restrictions on fixed and variable remunera¬tion of senior management.

• Obligatory representation of the Greek state and the HFSF on the Board of Directors.

• Appointment of a European Commission monitor to the board of directors and key board committees, tasked with overseeing business development, risk management and other essential business decisions.

• Signing an RFA with the HFSF, defining the degree and extent of the latter’s intervention in banks’ management decisions.

All four banks must fully implement their re¬structuring plans no later than the end of 2018. Therefore, this is the earliest that Greece’s sys¬temic banks would be completely free from State, HFSF and European competition commis¬sion interference in their management decisions.

6. A changing European banking landscape

The following are some key emerging trends and developments, which are currently forging a more competitive and challenging landscape for European banking:

• A prolonged period of deflation, negative in¬terest rates and sluggish economic growth.

• Intense competition from emerging, mostly niche, non-bank financial entities (shadow banking).

• The growing role of capital markets in Europe.

• Sweeping and costly regulatory changes aimed at enhancing banking supervision, prudential risk management, transparency and corporate governance.

• Growing restrictions in management and staff remuneration.

• Stricter reporting and monitoring require¬ments from the ECB and the SSM.

• Far-reaching technological innovation that is fundamentally transforming the operating and business models of banks and the channels for serving corporate, household and institutional clients. The Fintech phenomenon grows at an explosive rate, challenging the banks’ status quo.

• New burden sharing rules on depositors and debtors in the case of a bank failure.

All the above, ceteris paribus, would have a det¬rimental effect on economic growth and espe-cially on investment. In this challenging banking environment we should expect:

• Banks to further strengthen their capital base via additional capital increases, restructuring and downsizing.

• Banking disintermediation to accelerate sig¬nificantly, intensifying competition. Local and cross-border mergers and acquisitions to pick up. Consolidation in the industry is inevitable, as in Europe there is one bank per €118 bn of GDP, compared to one bank per €302 bn in the USA (PWC 2016 study).

• General focus on deposit gathering efforts, rather than on extending credit.

• Selling non-core assets and existing sub-opti¬mal business activities.

• Possible cut back of riskier activities and credits with heavier capital charges.

• Further rationalization and streamlining of op¬erating costs.

• Substantial investment in technology and transformation initiatives.

These significant changes, especially in technol¬ogy, will gradually transform the European bank-ing landscape and banks have to adapt and con¬solidate via a multi-paced transformation. Banks need to be prepared for disruptive competition, especially if they delay to take up these trans-formation challenges. The biggest enemies of systemic banks today are inertia and underesti-mating the seriousness of the challenge.

7. Is Capital Adequacy an Issue?

After nearly eight years of heavy output losses, an unprecedented sovereign debt restructuring, repeated stress tests, and three successive capi¬tal increases, Greek banks are now among the best capitalized financial institutions in Europe.

In my view, Greek banks are in a position to deal effectively with adverse market conditions, while at the same time manage their stock of non-performing loans and finance economic growth. The only genuine risk factor that I can see would be one induced by an unexpected regulatory change. That would only materialize if the European Commission competition author¬ity, or the SSM itself, suddenly changed the rules on deferred tax credits, negatively affecting the capital base of the Greek banks.

Today, Greek banks have more than adequate capital structures to support economic growth and effectively reduce the large stock of bad loans.

8. Conclusion: Weathering the Storm, Planning the Next Day

This article argues that the main challenges facing the Greek banking system today are related to:

• Overcoming tight liquidity conditions and re¬gaining access to international capital markets.

• Effectively managing and substantially reducing their stock of bad loans.

• Removing the fetters of the official sector that impede business development and growth.

• Adapting to a rapidly changing European banking environment.

To wit, if the question is “Can Greek banks help in financing Greece’s economic recovery?” ,then the answer is Yes, if Greece and the Greek govern¬ment can help its banks to recover by under-taking groundbreaking and convincing policy initiatives to improve credibility and market con-fidence, and to restore growth potential.

Part of the problem is inadequate communi¬cation. The country, in my view, does not do enough to communicate effectively to inter¬national market, opinion makers and investors progress recorded so far, our commitment to reforms and why Greece could be an interest¬ing and attractive investment opportunity. This is a serious shortcoming in a competing global environment.

In a juncture of multiple financial and political un¬certainties globally, in Europe and in the region, we do not have the luxury of any more back and forth. We all have to cooperate and act ef-fectively and swiftly.

Time is not on our side. ✿

(*) Nikolaos Karamouzis is the Chairman of Board of Directors, Eurobank Group, Emeritus Professor, University of Piraeus, nkaramouzis@eurobank.gr

(1) Summary from the Εurobank Research “Economy & Markets”, Volume X | Issue 2 | 2016.

The author wishes to thank Dr. Tassos Anastasatos, Eurobank’s Deputy Chief Economist for his valuable contribution.