By Dimitris Kontogiannis
The Greek economy requires years of expansion to reduce its record unemployment rate and raise depressed living standards to pre-crisis levels. Lending to the private sector will have to be normalized to facilitate this process, but this requires that banks deal effectively with their large stock of loan arrears. And the Greek authorities have to think hard about the costs and benefits of tackling the problem via a national bad bank scheme like other countries have done in the past or simply letting banks proceed with dedicated internal wind-down portfolio units.
In addition to the huge public debt overhang, the economy will have to be supplied with sufficient credit to be able to recover from its six-year recession and grow. Banks should have a key role but the large stock of bad loans will continue to hamper this effort unless it is dealt with fast and effectively, according to analysts and others. The large stock reflects the steep rise in the unemployment rate and the distress in the corporate sector due to the protracted cyclical downturn and own structural inefficiencies. An unspecified amount of bad loans comes from retail customers who don’t pay although they can, the so-called strategic defaulters. Given the situation, it is therefore not surprising that the issue of bad loans is high up on the agenda of bankers and government officials.
According to the International Monetary Fund’s fifth review, nonperforming loans (NPLs) – i.e. loans for which no interest has been paid for more than 90 days – and restructured loans accounted for about 40 percent of total loans at the end of 2013. The stock of bad loans alone rose further in the first quarter of this year and continues to climb according to analysts. The amount of NPLs is estimated at around 77 billion euros in Greece and 88 billion at group level and is likely to climb higher. It is the highest NPL ratio among eurozone countries except for Cyprus. The ratio of NPLs to gross loans is seen peaking in the last quarter of 2014 or the first quarter of next year, assuming the official projections for economic growth of 0.4 percent this year and faster next year materialize.
The idea of creating a national bad bank like Ireland’s NAMA or Spain’s Sareb to deal with the problem has come up again lately as arrears continue to rise, climbing to more than 35 percent of total loans at the end of the first quarter, and as the four systemic credit institutions prepare for the European Central Bank stress tests expected to be announced in October. It is known the IMF had objected to a national bad bank scheme in the past on the grounds it would have contributed to an increase in the country’s public debt.
Some high-level Greek officials now appear to share the same view, with both new Central Bank Governor Yannis Stournaras and new Finance Minister Gikas Hardouvelis objecting to the idea, according to credible sources. It is likely they object to the national bad bank scheme because they would like to use the reservoir of 11 billion euros in the Hellenic Financial Stability Fund (HFSF) for other purposes. These may be the reduction of the stock of public debt, filling the financing gap in the 2015-16 period or boosting any major bank’s core capital, if required, after the ECB’s stress tests. If their view prevails in the end, which is the most likely outcome, each bank will be called upon to satisfy any capital needs identified by the ECB stress tests and deal with bad loans individually. Banks have already organized internal recovery units with dedicated staff to deal with NPLs. At this point, given the extent of bad loans, it looks as if the management of NPLs may be a lengthy process, relying more on loan restructurings rather than write-downs.
On the other hand, proponents of the national bad bank scheme argue that a good amount of corporate and mortgage loans, in the order of 30 to 40 billion euros, could be transferred at a discount to valuation to a national bad bank set up for this purpose. They say foreign private funds are interested in participating in the capital of such a national bad bank as long as problematic assets are transferred at a discount from banks and there are other guarantees from the HFSF. According to them, this is a more effective way of dealing with NPLs, with the added benefit it will not dent investor sentiment regarding Greek stocks and bonds. They seem to be concerned that the ECB stress tests may identify large capital needs, forcing some or all the Greek banks to tap the markets for fresh capital for the third time since summer 2013. In this case, private investors who have put money in the banks may be frustrated and decide to flee Greek assets, dealing a blow to the country’s efforts to return to the bond markets since some international investors have put money both in stocks and bonds.
There is no question both sides in the debate have some strong arguments in favor of or against a national bad bank scheme. However, it is more important that an effective way is found to deal with bad loans to enable a normal flow of credit to the private sector, supporting the economy’s exit from the vicious cycle of the last few years. In this regard, the faster the problem of bad loans is tackled, the better for the economy. Muddling through is definitely not the best approach and in our opinion should be avoided.