Greek banks have no other option but to join forces as the economy appears to be sliding deeper into recession on the back of a restrictive fiscal policy, threatening to crowd out the private sector and denting consumer and business sentiment. Whether mergers and acquisitions (M&A) will be the right answer remains to be seen but it increasingly looks as if local banks have little choice. It is known that banking stocks are cyclical, in the sense that they usually do well when the economy or economies in which they operate do well. So it is not really surprising that Greek bank shares were the favorites of the so-called sell analysts, that is, those who worked for the large international banks, from 2004 through the middle of 2008. The Greek economy and most of the economies in Southeast Europe were growing fast during this period; there was liquidity and risk appetite was strong till the summer of 2007, making Greek banks a «growth story» many believed in. Even the steep correction in the May-June 2006 period, emanating from the liquidation of stock positions in emerging markets by hedge funds and real money accounts, did little to change this. The first clouds appeared in 2008 when some bank analysts downgraded their recommendations for Greek banks and slashed their target prices on concerns that the global credit crisis would hurt countries such as Romania and Bulgaria where local banks had expanded fast in the previous years. It was the first sign of weakness after many years for the performance of Greek banking stocks and their growth story as recession hit those neighboring countries and the local economy started showing signs of fatigue in the second half of 2008 and became more evident in 2009. Unlike other Western countries where banks were loaded with toxic assets requiring the intervention of the state to keep them afloat, the Greek banking sector did not become the Achilles' heel of the local economy. Greek banks had a very small, if any, amount of toxic assets on their books. Moreover, they funded most of their group loans from their deposit base. Although they expanded their loans to households and corporations fast from 2000 through 2009, their loan-to-GDP ratio of about 85 percent was smaller than the eurozone average ratio of about 115 percent and much smaller than Ireland's or Spain's, estimated at 199 and 173 percent, respectively. Local banks also took steps to boost their capital adequacy ratios, partly issuing preferred shares to the state in exchange for government bonds. The Greek banking system has reportedly a shared equity of 36 billion euros, supporting assets of about 500 billion euros, leading to an asset ratio of more than 7 percent, which is satisfactory by international standards. However, the health of the banking system and the health of the Greek economy are intrinsically linked. In Greece, it looks as if the banking system could be the victim of the state rather than the other way around. Already, Greek banking stocks have been paying a high price since they are the easiest to short sell in an environment where short-selling government bonds or/and the equivalent of purchasing credit default swaps (CDS) on Greek public debt has become more cumbersome. Concerns about Greece's sovereign debt crisis has definitely affected local banks in a number of ways: With the economy in recession, loan volume growth has ceased and is likely to become negative later this year. The sharp drop in the value of Greek bonds has also adversely affected their profitability and their capital, although the reclassification of some bonds to the portfolio category «held until maturity» has helped them to avoid the worst. Still, their cost of funding has been rising since March as competition of deposits heats up at the same time that deposits are down and international wholesale markets remain closed. Of course, banks «reprice» their loans but it is questionable to the extent this can work in a recessionary environment. Moreover, nonperforming loans are on the rise as recession sinks in and are expected to increase further, forcing banks to set aside more provisions for bad loans in the quarters ahead. In this kind of environment, the weaknesses of some major players have become more evident, with liquidity appearing to be the most pressing. Under these circumstances and with the economy projected to shrink further in the coming quarters, banks have no option but to take a proactive stance and pursue bank marriages of substance and not of convenience. A bank of a bigger size is likely to access international wholesale and interbank markets faster in the future, especially if the sovereign country makes progress on the fiscal front, and be regarded as better credit by credit rating agencies. In addition, M&A will also ease competition among banks for deposits and help boost their margins. There is no doubt these experiments will run into operational problems but will become more manageable with structural reforms implemented in the labor market and elsewhere. From the lineup of large and medium Greek banks, two stand out as possible candidates for initiating consolidation: The National Bank of Greece and Hellenic Postbank (TT). Whether this will be the case remains to be seen. However, if bank marriages are to take place, the sooner they do so, the better.