Greek debt costs could rise due to financial regulators’ new rules

At the same time as Greek politicians from the two major political parties were fighting it out in Parliament over who was to be blamed for the size of the budget deficit last week, global bank regulators were reaching an agreement on the draft accord for the new financial architecture, known as Basle II, which is likely to have implications on the borrowing cost of the Greek state, banks and corporations. After nearly five years of haggling over how to change the 1988 accord on capital adequacy, dubbed the Basle I accord, global regulators finally agreed last Tuesday on a new and complicated set of rules to regulate today’s banking institutions operating in a much more sophisticated financial landscape. According to the 1988 one-size-fits-all approach, hailed at the time as a milestone in international banking regulation, banks would set aside 8 percent of their capital in relation to loans extended to creditors, distinguished between sovereigns, banks and corporations and their geographical origin. Under the Basle I accord, governments belonging to the OECD and supranationals were not weighted, banks were assigned weights between 20 percent and 50 percent depending on their location, whereas corporations were weighted at 100 percent. This meant that banks extending loans to OECD countries such as Greece, Germany and Turkey, to mention a few, would not set aside capital for doing so because these countries had a zero risk weighting. Non-OECD countries with better sovereign credit ratings, such as Cyprus, were at a disadvantage because they were weighted at 100 percent. Bonds issued by banks in OECD countries were weighted at 20 percent. Under the new rules of Basle II, banks will calculate minimum capital requirements by assigning a risk weight to assets, taking into account each customer’s credit risk profile. According to the simpler approach of 1988, credit ratings did not really matter for regulatory purposes provided the creditor belonged to the OECD domain. In the new scheme, risk weights will be derived either from credit ratings of borrowers assigned by international rating agencies such as Standard and Poor’s, Moody’s and others or rely on complex formulas provided by the Basel Committee. In addition, there will be a charge for operational risk referring to human errors, fraud etc. Although few in Greece paid attention to the developments outlined above, there is good reason to do so since the new draft adversely affects all interested parties, including the government, the banks and local corporations. This is even more the case following the widening of the budget deficit to 3.2 percent of GDP last year and the ominous predictions about this year’s deficit, seen ranging between 3.5 and 4.0 percent of GDP, despite Finance Minister George Alogoskoufis’s vow to do everything possible to keep it below the 3.0 percent mark. With the public debt-to-GDP ratio revised to 103 percent of GDP in 2003 and all indications pointing to a debt ratio reading over 100 percent of GDP this year, the prospect for Greece getting its credit rating for its long-term debt upgraded looks doubtful at best. Given the European Union’s decision to go ahead and start work on the implementation of the new, complex rules in July, there is not much time left for Greece to put its public finances in order to get a much-needed rating upgrade. Standard & Poor’s upgraded Greece long-term credit rating to A+ from A in June 2003, bringing it line with Moody’s, which had upgraded it to A1 in November 2002. Both organizations at the time cited the improvement in public finances, mainly in the form of the budget deficit as a percentage of GDP, and the country’s nominal and real economic convergence with the rest of the EU (European Union) as reasons for the upgrade. The international rating organizations have long called for reducing the debt ratio and pressing ahead with structural reforms, mainly pension reforms, but inadequate progress on that front have kept Greece’s credit rating at the lowest level within the EU15 in the past. Given the new fiscal realities, one wonders if Greece should be concerned about an unfavorable change in its credit rating outlook rather than hoping for an upgrade either this year or next. Assuming the country’s long-term debt credit rating remains at the same level, the cost of borrowing will increase under the Basle II Accord, further aggravating the fiscal imbalances. Unless Greece manages to get an upgrade to AA- by S&P and Aa3 by Moody’s, it will have to pay larger spreads on its bonds to its bank creditors to compensate them for setting aside capital. Under the present system, the risk weight of Greek government bonds is zero so foreign banks do not have to preserve capital when keeping them in their books. Some 60 percent of the country’s public debt is in foreign hands. Under the new system this will change, since their risk weight will rise to 20 percent from zero. Similar changes will apply to local banks and corporations issuing bonds maturing in more than three months as the assigned risk weight will go to 50 percent from 20 percent at present. Higher borrowing costs All in all, Greece has another reason to streamline its public finances sooner rather than later in order to avoid paying the price of higher borrowing costs under the new accord on regulating the international banking system, dubbed Basle II. This is not good news for the newly elected conservative government and the local business community, especially banks, but it is something that must be taken into account very seriously by those formulating economic and business policy. Failure to do so will only cloud the country’s future economic prospects and threaten its living standards.

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