Lending growth holds risk for banks in case of a slowdown

Greek banks believe that healthy loan growth will continue to boost their revenues and earnings in the next few years, betting on low interest rates, fast GDP growth, and an under-leveraged economy. They may be right. Nevertheless, it cannot escape anybody’s attention that projected strong loan growth, coupled with generally limited experience in managing credit risk, raises concerns about the credit quality of their loan books in the context of an economic slowdown and a likely increase in euro rates after 2004. Although it is relatively safe to say that the Greek economy will continue to grow this year and the next, there are doubts whether this will continue to be the case from 2005 onward. When approving Greece’s 2002-2006 stability program, the European Commission observed that an annual average growth rate of 3.8 percent in the 2002-2006 period is feasible and forecast GDP (gross domestic product) growth of 3.9 percent in 2003 and 3.7 percent in 2004 versus an estimated 3.5 percent in 2002. The Greek economy grew by 4.1 percent in 2001. All these forecasts, as well as the more optimistic official ones, are based on the well-founded assumption of strong investment spending as infrastructure works linked to the 2004 Olympic Games are completed and other projects co-financed with European Union funds continue. It is estimated that EU structural funds will account for about 4 percent of Greek GDP through 2006. On the other hand, private consumption spending, the other major component of aggregate demand, is forecast to grow more slowly than the GDP growth rate in the same period. This favorable macroeconomic environment, coupled with the existence of real negative interest rates, the by-product of declining nominal euro rates and Greece’s easing, but still stubbornly high, inflation make a strong case for continued loan growth through 2004. Nevertheless, a look at the four major Greek banks’ non-performing loans (NPL) to total loans ratio at the end of 2001 does not please. Figures show that the four major Greek banks, namely National Bank of Greece, Alpha Bank, Commercial Bank of Greece and EFG Eurobank Ergasias, showed an average NPL-to-total loan ratio of 4.2 percent at end-2001. This is higher than the 2.3 percent ratio reported by EU retail banks and the 2.9 percent by all European banks according to Merrill Lynch estimates. Only Italian retail banks exceeded it with 5.4 percent, versus 1.6 percent for Portuguese retail banks and 1.3 percent for Irish banks. Still, the figures may not be telling the whole truth. Greek banks, with the notable exception of Alpha Bank, apply a looser NPL definition, meaning banks are allowed to accrue interest on overdue loans for six months (180 days) versus the 90 days used by most other European banks. Alpha Bank applies the 90-day rule for consumer, mortgage and corporate lending while Commercial Bank and EFG Eurobank apply it only to consumer credit, including credit cards. National Bank utilizes the 100-day rule for consumer credit and the 180-day rule for the other categories. Moreover, the major Greek banks furnished, on average, provision coverage of 78 percent for NPLs at end-2001, against an average of 93 percent for European retail banks and 91 percent for all European banks. The NPL provision coverage for Irish banks, which also operate in a growing economy, reached 117 percent while the same ratio climbed to 153 percent for Portuguese banks operating in a tougher macroeconomic environment. All this does not mean that Greek banks have not taken measures to improve the credit quality of their loan books. In the last five years, they have experienced an average loan growth in excess of 20 percent. Prior to 2000, banks were allowed a maximum period of 12 months to accrue interest on overdue loans. Still, a number of analysts and others express concerns over credit quality issues, giving the impression that a small portion of local households is over-leveraged and that the Greek economy will slow down after 2004 as the boost from Olympic Games-related spending fades away and euro interest rates start heading back up. Perhaps realizing this threat, the Bank of Greece, the country’s central bank, recently tightened up provisions for consumer loans and probable default loans used in calculating banks’ solvency ratios. Analysts point out that the required introduction of IAS (International Accounting Standards) at end-2003 will force banks to apply the standard 90-day rule on NPLs. This may have a negative impact on some banks’ bottom-line reporting solely under the Greek Accounting Standards since it may lead to an increase in NPLs. It should be noted that EFG Eurobank Ergasias and Alpha Bank already report under IAS and NYSE. Listed National Bank of Greece reports under US GAAP. Only Commercial Bank and Piraeus Bank do not report under IAS. Commercial’s NPL-to-total loan ratio stood at 5 percent at end-2001 and Piraeus’s at just 2 percent. Commercial’s NPL provision coverage was just 60 percent while Piraeus’s was 106 percent. There are good reasons to believe that banks are right about the future prospects of Greek retail banking. After all, consumer credit has yet to be fully liberalized and unsecured household lending is still low, at about 20 percent of GDP versus an estimated 46 percent in the EU. Yet this potential could easily lead to a significant increase in non-performing loans, hampering banks’ earnings growth after 2004. To this extent, it may pay for a Greek bank to be less liberal in lending practices now that the economy is growing rather than face the dire consequences of imprudent lending later when the economy slows down.

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