ECONOMY

Urgent need for bank reform and recap

The negotiations between the Greek government and the troika over the future of the merger between National Bank of Greece and Eurobank Ergasias will likely lead to a compromise. Whatever the outcome, the model of local banks will have to change drastically to adapt to the country’s new economic reality. Although some steps have been taken in that direction by credit institutions, the strategy of buying time on hopes of an economic turnaround appears to have backfired, increasing the cost for all stakeholders.

According to press reports, the representatives of Greece’s international creditors have expressed strong reservations about the National-Eurobank merger, focusing on the large size of the new entity and the additional recapitalization funds it may require ahead if the economy continues to disappoint. Obviously, the troika thinks the risk would be lessened if the share capital increases of the two banks proceed separately, in which case both National and Eurobank would most likely be nationalized. The alternative is to allow the combined group to proceed with a share capital increase a couple of months later after the legal merger of the two banks is completed, seen in May-June.

It is noted the total assets of the combined group will be 178 billion euros and are similar in size to the country’s gross domestic product, estimated at around 183 billion euros in 2013. The resolution and recapitalization costs of the local banking sector have been estimated at around 50 billion euros and any amount in excess would have to come either from official loans, adding to public debt, or other sources.

Of course, all the figures about the size of the new group were known months ago, when the deal was announced, and nobody seemed to object at the time, leading some analysts and others to think the events in Cyprus may have played a significant role in shaping the opinion of the troika. Readers are reminded that the assets of the Cypriot banking system were more than eight times larger than the island’s GDP. This meant even a small, adverse change in the banking system’s capital requirements could have put enormous pressure on Cypriot public finances, potentially leading to the country’s default. To avoid a big increase in the country’s public debt-to-GDP ratio, the EU and the Nicosia government agreed to bail in the uninsured depositors at the country’s two largest banks, one of which it was decided would be be liquidated.

However, some local bankers and others see another motive behind the troika’s apparent reservations about the National-Eurobank merger. They argue the stance of the creditors’ auditors fits the interests of foreign banks because the latter could buy some of the assets of the two Greek banks cheaper if the deal did not go through. It is another version of the critique directed at the EU by some Cypriots who argue the bailout also aimed at breaking up the island’s banking sector so that other EU banks could get a piece of the business generated by Russians and others there.

Whatever the case, some things stand out. First, the recapitalization of the Greek banking sector has been delayed for quite some time even though everybody recognizes its importance in alleviating the credit crunch experienced by the country’s private sector. A number of officials and others bear responsibility for this delay, including the top executives of the big banks who opted to kick the can down the road, hoping an improvement in the economy would have helped attract private investors in the planned share capital increases, keeping the banks in private hands.

Second, the drastic restructuring of Greek banks dictated by the new economic reality at home has not taken place. This is despite the fact that almost all credit institutions have taken some steps toward containing operating costs and raising provisions for nonperforming loans over the last few years. Even top bankers recognize in off-the-record conversations that the sector and its 50,000-plus employees have not been affected as much by the crisis as other parts of the economy. This is largely thanks to taxpayers’ money which helped banks stand on their feet and the ECB’s liquidity support.

Unfortunately, the economy has failed to live up to the bankers’ and others’ expectations. This means the pain from the rationalization of the banking groups will be greater and the final bill for the recapitalization may end up being larger than estimated. Even now, the structure of the banks assumes they operate in a fast-growing economy which produces a lot of interest income and fees rather than an economy mired in recession, facing years of slow growth ahead.

Moreover, banks will have to reduce their exposure to the ECB by tens of billions of euros and return billions to the Hellenic Financial Stability Fund (HFSF) in the next five years.

To adjust their model to the new reality, a significant number of branches in Greece and abroad will have to close or merge with others and operating expenses will have to be cut significantly to the tune of 30 percent or more on average, depending on the institution, experts say. This means many jobs will be lost and salaries will be slashed. In addition, some assets which can attract investor interest, most likely abroad, will have to be shed. The result should be leaner, well-capitalized credit institutions focusing largely on the domestic market.

Of course, overhauling the model is a very difficult task and will be tougher because it will have to be carried out in a relatively short period to make up for time wasted by the management teams of the large banks. In this regard, even if the troika agrees to give the green light to the merger between National and Eurobank, the strings attached will likely be very demanding.