Avoiding the risk of creditless recovery
Greek banks will be on sounder and more solid footing after covering their capital needs – put at 6.4 billion euros by the central bank’s stress tests on the heels of the BlackRock Solutions review – but the economy may still be looking at a creditless recovery. This would be neither the first nor the last time that a country goes through this experience, which is usually associated with weaker economic growth rates and is best avoided.
The Bank of Greece last Thursday announced the results of the much-awaited banking sector stress tests. The results, which were more comprehensive and inclusive than the stress tests based on BlackRock’s first review, estimated local banks’ capital needs at 6.4 billion euros. Among the four core banks, Eurobank needs about 2.95 billion euros, National Bank of Greece about 2.2 billion euros, Piraeus Bank about 425 million euros and Alpha Bank about 262 million euros. About 600 million euros are accounted for by two other non-core banks, Attica and Panellinia.
All estimates were based on the baseline scenario, reflecting the macroeconomic projections in the IMF’s review last July. Cumulative real GDP losses were put at 26 percent for the 2008-2015 period. Under the adverse scenario, the total capital needs of all six Greek banks were estimated at more than 9 billion euros.
Piraeus was the first to respond, announcing plans to raise up to 1.75 billion euros or 20 percent of 2013 equity. The amount will boost its capital base and help repay 750 million euros to the state for preference shares issued in the past. Alpha also announced a plan to raise up to 1.2 billion euros or 16 percent of 2013 estimated common equity, with Citigroup and JP Morgan guaranteeing the success of the action. Alpha plans to strengthen its capital position and also pay back preference shares worth 940 million euros.
It has also been suggested that Eurobank plans a share capital increase of more than 2 billion euros with foreign funds such as Fairfax, Apollo, York Capital and others reportedly interested in taking part. On the other hand, National said in a statement that it will seek to cover its 2.2-billion-euro needs by other means and will not proceed with a share capital increase. National and Eurobank will not replace preference shares by issuing common shares.
Assuming Piraeus and Alpha are successful and repay the preference shares while bonds given to National and Eurobank in exchange for preference shares in the past are rolled over, Greece will be able to fill this year’s funding gap, estimated at 4.5 billion euros, without a new bailout loan. This is not unlikely and may help sentiment locally because it would bring the exit from the bailout program closer. On the other hand, some analysts and bankers think it would have been better if Piraeus and Alpha used the proceeds from the share capital increases to further boost their capital positions instead of redeeming their preference shares at this stage. They argue that this would have reduced market concerns about the large stock of non-performing loans (NPLs) and make it easier for them to provide credit to the private sector.
There is no doubt that the actions planned by Greek banks to strengthen their capital positions are positive. After all, bank credit plays an important role in propping up economic activity by financing investments in fixed assets, working capital, exports and parts of consumption. Nevertheless, it should be noted that figures may show a flat or even small negative year-on-year change in credit, but the impact on economic activity could still be positive. This will be the case if the available credit is channeled to productive companies and sectors and if non-viable firms are cut off.
According to the latest data, credit contracted 4 percent year-on-year in January from 3.9 percent at the end of 2013, as banks sought to deleverage in view of the stress tests conducted by the central bank and later this year by the ECB. However, it should be noted that the contraction in bank credit is not exclusively linked to limited supply but also to the lack of demand by financially healthy companies. The latter are expected to seek more loans as the economic outlook brightens. Moreover, banks are expected to engage in further loan restructurings ahead, facilitating the deleveraging of private sector firms.
Policies aimed at restoring financial intermediation, such as removing the stress on bank balance sheets via recapitalization and reducing the indebtedness of viable private companies via debt restructurings, are highly recommended for countries facing the prospect of a creditless recovery. Greece is a likely candidate since the real GDP is projected to grow by 0.4 to 0.6 percent this year while bank credit is not seen expanding.
Recent events in Ukraine, Russia and Turkey are not helping, as Greece depends on tourism and exports to get out of its six-year recession. Moreover, there is considerable uncertainty regarding 2015 for political and other reasons.
History shows output growth is on average much lower in creditless recoveries than in normal ones and is sometimes followed by stagnant economic activity. It is therefore important for Greece to avoid falling into the creditless recovery trap. Removing obstacles to efficient financial intermediation is one of the keys because it can contribute to boosting fixed asset investments and exports.
