Banks have work cut out after recap

Completing the recapitalization of Greece’s four core banks is a long-awaited step in the right direction but it will neither open the spigots of credit to the economy nor address the main challenge facing local banks in the years ahead – stagnant or slowly growing business.

As expected, three of the four core banks secured the minimum 10 percent private participation in their share capital increases to remain under current management.

National Bank of Greece and Alpha Bank have succeeded in raising more than 10 percent of the required capital from private investors, and Piraeus Bank is also expected to follow suit, mainly thanks to the deals it struck with France’s Societe Generale and Portugal’s BCP. On the other hand, Eurobank Ergasias was fully recapitalized by the HFSF (Hellenic Financial Stability Fund).

Readers are reminded that the capital needs for all Greek commercial banks were estimated at 40.5 billion euros in May 2012, with 27.5 billion euros corresponding to the four core banks, namely National, Alpha, Eurobank and Piraeus.

The Greek central bank again reviewed their capital needs in the fall of 2012 and concluded the estimated capital needs were adequate. The capital needs of National Bank were put at 9.75 billion euros, Alpha’s at 4.5 billion, Eurobank’s at 5.8 billion and Piraeus’s at 7.3 billion.

To a large extent, the capital gap stemmed from the restructuring of the Greek public debt, a process known as PSI, or private sector involvement.

The four banks suffered losses of 28.2 billion euros from bonds and sovereign loans while total losses for the system stood at 37.7 billion euros.

However, while the completion of the recapitalization is a positive development in itself, it may not be the last one, at least for one or more of the systemic banks. This may be the case if the economy remains in recession, giving rise to more bad loans. Banks will be subject to new stress tests on their loan portfolios in the next few months, which may point to the need for more capital.

To fully or partly fill the capital gap, they will have to move ahead with the disposal of some core and non-core assets, count on ongoing asset-liability exercises to boost their capital adequacy ratios and, generally speaking, speed up deleveraging.

In their business plans submitted to the central bank prior to determining their capital needs, a double-digit degree of deleveraging is assumed by each bank according to their executives.

Of course the picture will brighten if the government and some international banks are right in predicting that the Greek economy will stabilize later this year and start recovering in 2014. Analysts say banks employing internal models to assess risks have leeway in propping up their adequacy capital ratios.

So, banks will face capital constraints in turning on the credit tap to the economy, as many expect, despite the completion of the recapitalization. However, an even bigger constraint may turn out to be liquidity. The government and bankers are counting on the return of deposits and banks’ greater access to the interbank market following the recapitalization, expecting it will boost liquidity.

Nevertheless, the continuing recession and the anticipated stagnation of disposable incomes in the next few years do not support the case for a significant increase in deposits. Moreover, Greek banks will have to gradually decrease their dependence on the Eurosystem during the same period, which will make it more difficult for them to provide credit to companies and households – contrary to popular belief.

In other words, the recapitalization and restructuring of the Greek banking sector – even if no additional capital is needed after the new stress tests to be conducted in the coming months – may ease credit conditions in the economy, but it will not bring about the normalization envisaged by many.

In addition to the capital and liquidity constraints in the quarters and likely years ahead, banks will have to cope with a bigger problem: stagnant or insufficiently growing business. Retail credit institutions traditionally make money from interest and fees charged on loans and much less from other sources such as trading income, asset management, bancassurance.

Although the baseline scenario of the Greek adjustment program forecasts satisfactory growth rates in the future, many doubt whether the economy can grow by 2 percent or more on average during the 2013-20 period, while some even think it may average close to 1 percent. This is a far cry from the average gross domestic product growth rates experienced during the 1995-10 period, during which the banks learned to operate and earn huge profits.

With credit growth to the economy in single digits at best, the banks cannot count on revenues from interest income and fees in order to make handsome profits and in turn generate internal capital, while satisfying their shareholders.

Consequently, inadequate business growth ahead represents the major challenge ahead for the banks and their top management teams. The successful completion of the recapitalization is a positive development, but one cannot realistically hope that it can do more than just ease credit conditions in a cash-strapped economy.

To rise to the challenge, the top brass of Greek banks will have to manage things differently than they used to in the last 15 years or so.