Faced with a protracted stock market slump, the five major Greek banks have been increasing their exposure in the fast-growing local retail market, betting that the combination of Greece’s projected high GDP growth rates and low credit penetration provide a fertile ground for earnings growth. They have been also able to pass the European Central Bank’s (ECB) rate cuts on to their depositors, boosting their net interest income since they did not reduce their whole array of adjustable loan rates accordingly. Nevertheless, the Finance Ministry’s politically motivated decision to issue debt instruments offering better yields should make banks rethink the limitations of their net interest income-boosting strategies. It is known that the major Greek banks took advantage of the ECB’s decision to cut its refinancing rate by 50 basis points to 2.75 percent in early December to pass it to their deposit base, despite the fact that Greek consumer price inflation was running at over 3.5 percent in 2002 and they already enjoyed wider deposit spreads vis-a-vis their eurozone counterparts. The desire for higher profits was definitely behind this decision, which was facilitated by the fact that some banks, namely National Bank and Alpha Bank, appear to fund even more than 90 percent of their interest earnings assets by deposits. The average deposit-to-interest earnings asset ratio stood at 86 percent for the five major Greek banks at end-September versus 58 percent in the European Union. Although the above ratio for the five major Greek banks seems to be on the decline, it also shows that they continue to rely heavily on their deposit base to enhance their net interest income. The latter constitutes the major source of revenue growth for Greek banks in the last three years, which have been characterized by steadily shrinking trading income, and their inability to seriously address the problem of their inflexible cost base. Indeed, according to published nine-month results in 2002, National Bank of Greece, the country’s largest commercial bank, saw its total income decline by 16 percent year-on-year on the back of a sharp drop in trading income, on the order of 80 percent. Income from commissions also eased 3.0 percent, but net interest income rose by 2.0 percent. On the other hand, total operating expenses increased 5.0 percent on the heels of a 9.0 percent increase in administrative expenses while staff costs were contained at 1.0 percent. A similar story occurred at Alpha Bank, the country’s second-largest bank, where total income fell 6.0 percent year-on-year January-to-September 2002. There, trading income dropped 49 percent, commissions were flat and net interest income rose a mere 2.0 percent. Total operating expenses were up 9.0 percent on the back of an 11-percent rise in administrative expenses and 6.0 percent in staff costs. EFG Eurobank’s total income rose 2.0 percent year-on-year despite a 171-percent drop in trading income, thanks solely to a 15-percent increase in net interest income since commission income eased 1.0 percent. EFG Eurobank’s total operating costs rose 8.0 percent year-on-year, with staff costs up 11 percent and administrative expenses down 2.0 percent. Commercial Bank of Greece saw its 9-month total revenues fall 16 percent versus a year earlier, with trading income down 84 percent but net interest income and commissions up 12 percent and 1.0 percent respectively. Operating costs increased 7.0 percent on the back of a 10-percent rise in administrative expenses and a 4.0-percent increase in staff costs. Finally, Piraeus Bank, the country’s fifth largest, registered a 7.0-percent rise in total income despite a 91 percent and 6.0-percent drop in trading income and commissions respectively, banking on a 32-percent rise in net interest income. Total operating expenses were up 13 percent as staff costs surged 21 percent and administrative expenses declined 2.0 percent. Analysts warn that the major Greek banks’ heavy reliance on their deposit base relative to their European peers to fund their push into the lucrative retail banking – at the same time as they offer comparatively lower rates to their depositors – entails risks. They say the Finance Ministry’s move to offer debt instruments, such as one-year inflation-linked notes yielding higher returns, highlights those risks. They say Greek banks enjoy a tremendous advantage in being able to offer little in rates – ranging from as low as 0.0 percent to 1.0 percent – for a large amount of deposits, but they add that their depositors, faced with negative real interest rates, will increasingly look for higher yield products. This means bank deposit growth may lag considerably behind loan growth in 2003 and beyond, forcing Greek banks either to seek more funding in the euro inter-bank market or offer their depositors higher rates to keep them happy. Either way, this will translate into a tighter net interest margin and lower interest income than otherwise. Of course, things may get more complicated if there is a slowdown in loan growth, because in that case banks are likely to be forced to slash their lending spreads in order to retain or increase their market share in retail banking. In that case, pressure on net interest income will intensify and come from the asset as well as the liability side. The five major Greek banks have rightly pursued expansionary policies in the growing domestic retail market in a bid to replace their declining volatile trading income with more stable and promising net interest income. In doing so, though, they have relied heavily, one could say excessively, on their large deposit base to fund their expansion, because it offers cheaper funding than the inter-bank market. However, this policy implies a greater risk of net interest income weakness in the future. The Finance Ministry’s decision to issue high-yielding debt instruments has simply highlighted it. So, it is up to the major local banks to take the proper steps to address this problem but, unfortunately for them, it is not that simple.