Credit market must come clean

The Greek economy will not get out of its protracted slump and grow if the domestic banking system is not in a position to smoothly finance the activities of companies and households.

This will not happen if the credit institutions do not recognize the losses from their bond holdings and bad loans, and if existing or new shareholders, including the state, do not put their hand deep in their pockets to boost the banks? equity capital. The longer this process takes, the worse it is for them and the local economy.

The shareholders of Greek banks have seen their shares savaged by market forces on the Athens stock exchange in the last few weeks, losing some 40 percent on average in the last 30 days or so and 60 percent or more in the last two months.

Some of them have been in disbelief, thinking the market has been unfair to the banks. They would not feel this way if they took a look at some other well-known banks in other countries, such as Ireland and Portugal, that have been hit by the sovereign crisis.

Portugal?s BCP Millenium bank, with about 100 billion euros in assets, had seen its market capitalization fall to about 1.7 billion euros, while Allied Irish Bank had seen its market cap drop to 30 million euros recently, according to one analyst. Moreover, Bank of Ireland, with almost double the assets of Greece?s largest bank, had seen its market capitalization hover around 2.6 billion euros recently.

Just to give an example for the sake of comparison, National Bank of Greece, the country?s biggest commercial lender with about 117 billion euros in assets at the end of last March, had a market capitalization of about 2.7 billion as of last Friday, following the sharp fall of its shares last week.

So, the market is ruthless no matter which country one looks at if there are reasons for acting so. In the case of local banks, it is their Greek government bond holdings and non-performing loans that have hurt them most.

This is because the top executives of the Greek banks have made the same mistake as the Greek government in dealing with the public sector and the European leaders in tackling the sovereign crisis: Kicking the can down the road and hoping things will get better so as to recoup most of their bond losses and see a great deal of problematic loans turning again into good ones.

But the markets obviously do not think in these terms. By driving their shares lower, market participants showed the banks? top executives and shareholders that this is not a game they can win.

Very simply, the market would have marginalized the banks on the Athens bourse by pushing their stock prices further down so at some point some banks would cease to really exist.

By sticking to the old line, the major shareholders of the banks would have come to grips with reality, meaning it is of no importance who controls a bank that cannot give out loans.

The likely merger deal between Alpha Bank and Eurobank EFG with the presumed participation of a company from Qatar attempts to entertain these concerns by likely boosting the equity capital of the new entity. It is noted that the Qataris already have an equity stake of less than 5 percent in Alpha Bank.

However, it is too early to say whether the deal will be successful without knowing its details, and, most importantly, the extent of the equity participation of the Qatari company and the major shareholders of the two banks, namely the Costopoulos family on the side of Alpha Bank and the Latsis family on the side of Eurobank EFG.

Still, Greek banks will not be able to convince the investment community and their foreign peers and regain access to the interbank market and liquidity if they do not mark-to-market their bond holdings, write off billions in bad loans and take more provisions for non-performing loans in the order of billions of euros.

Participation in the PSI (private sector involvement) scheme of the second Greek rescue package where bondholders exchange or rollover existing debt paper into bonds with maturities ranging from 17 to 30 years may shed some light on this issue.

The results of the diagnostic tests on the loan portfolios of Greek banks by BlackRock Solutions may also ensure markets that local banks have brought the loan skeletons out of their closets.

However, this process, which took a month or so in the US, is estimated to take several months in Greece and the markets do not seem to have that kind of patience, judging by the way they have sold off their stocks.

It is therefore imperative that local banks give up on the ?kick the can down the road? mentality by first coming out clean and secondly by boosting their equity capital to beef up their capital adequacy ratios and regain market confidence.

Whether this can be accomplished in the context of a mega-merger is not as important as it is to pass the market test.

We argued at some point that Greece needs its own version of a supply side revolution in the form of lower taxes and regulations to boost the competitiveness of the economy and restart the engine of growth. To do so, the engine also needs fuel and this can be provided mostly by bank credit and foreign direct investments via privatizations. But to work, the engines have to be cleaned first.