The Greek economy has been contracting for more than four years and the country is about to complete the biggest debt restructuring (PSI) in history, but local banks have done less than expected to adjust to the new unfavorable macroeconomic conditions of stagnation and slow growth that lie ahead. It is time they came up with a story.
Experts say it is imperative for a debt-laden country that is undergoing large-scale fiscal consolidation and many structural reforms to have a well-capitalized banking sector to fund the private sector. This is especially true when the country cannot devalue its currency to improve its terms of trade and absorb part of the shock.
Both the first and second Greek economic adjustment programs agreed with the International Monetary Fund and the European Union foresee capital injections for local banks to ensure they continue to play their intermediary role and avoid a credit crunch that could lead to depression and possibly a hard default.
According to businessmen, individuals and others, Greece?s economy is suffocating because of a lack of bank credit, the main source for funding investment, consumption and exports.
However, a closer look at the data does not fully support this argument. Loans to households and companies stood at about 248.7 billion euros at the end of last January, compared to 249.3 billion at the end of 2009 and 251.7 billion in May 2010 when Greece accepted the first EU-IMF package of 110 billion euros. In other words, credit was compressed by just 600 million euros between end-2009 and January 2012 and 3 billion euros between May 2010 and two months ago. No one can say these numbers constitute a credit crunch.
Perhaps there is another explanation, but one which has to do with the shadow Greek banking system, namely the extensive use of checks as a form of credit by local businesses. These checks provided extra liquidity to the economy in the past and efforts to curtail their use by banks must have contributed to the liquidity squeeze.
While loans appear to have been affected little by the protracted economic slump, deposits have experienced a severe drop over the same period. Deposits by firms and households fell to about 169 billion euros last January from 237.5 billion at end-2009 and 220.2 billion in May 2010. In other words, bank deposits dropped by 68 billion euros from end-2009 through January 2012 and 51.2 billion between May 2010 and January 2012.
It is obvious Greek banks would not have been able to maintain the same level of lending and a significant increase in bad loans without cheap financing from the ECB and the Greek central bank?s emergency funding mechanism (ELA). It is estimated local banks have received liquidity in excess of 110 billion euros in the first months of 2012 by posting collateral whose nominal value exceeded 150 billion.
It is therefore fair to conclude that bank deleveraging has not been as big as implied by the fall of the nominal gross domestic product in the last few years and the consensus trajectory of the Greek economy in the next five to 10 years. It is also clear that liquidity is a major obstacle and will continue to be for some time at least as long as the economy continues to contract and people?s confidence in the banking sector is not restored.
Fully aware of the need to regain the confidence of the general public and provide credit to creditworthy companies, the new loan agreement between Greece and its official creditors allows for some 48 billion euros to be set aside to recapitalize local banks and so-called bank resolution costs. This sum appears large enough at this point to cover large losses from their Greek government bond losses due to PSI (private sector involvement) and extra provisions for nonperforming loans in the next three years.
It is reasonable for the EU and the IMF to expect that private shareholders will participate in the share capital increases to a minimum degree so they remain in control of the banks. However, it will be interesting to see whether these expectations materialize. This is because the share capital increases will be much, much bigger than the current market cap of the banks and it is more likely that those who join in may find out they will lose even more after the recapitalization is over.
Unfortunately, Greek banks have followed the state in kicking the can down the road instead of overhauling their business model earlier to take into account the fact that the local economy will grow slowly for years, with deleveraging rather than asset growth being the new norm.
The insufficient lack of progress in restructuring their franchises over the last couple of years will cost their shareholders more now and their employees a bit later unless they want to be allowed to turn the banks into Japanese-style zombies. Of course, restructuring is always painful since it will result in hundreds of branches being closed down or merged in the domestic market to cut operating costs by 30 to 40 percent to have a material impact.
For listed companies, including banks, to be able to attract private capital they will have to have a convincing story to sell to the investment community. Since Greek credit institutions can no longer preach the growth story of the past with the expanding franchises in the fast-growing economies of so-called New Europe, they will have to come up with a new one.
But there is only one story left: It is the story of restructuring and value creation that could help attract private capital and avoid their nationalization. The sooner they start working on this story, the better for everybody, including their shareholders and the Greek economy. They have already lost valuable time.