Market participants may have doubts about the ability of the Greek economy to grow at a 3.9 percent clip next year. There is no doubt, however, about the ability of the major Greek banks to deliver double-digit earnings growth in 2005, some of whose shares have been bid up to multi-year highs. High loan growth in the domestic market has underlined earnings resilience in the last few years, but the likely deceleration of GDP growth next year and the gradual tightening of spreads point to future earnings fatigue. In line with this, Greek banks have no choice but to speed up efforts to beef up their business in neighboring countries, including Turkey. The major Greek banks have been able to produce better-than-expected earnings growth in the past few years by relying mainly on strong top-line growth and less so on more effective cost control. Operating in an environment characterized by high GDP growth rates and low interest rates, they have been able to boost loan volumes, especially mortgages and consumer loans, to previously under-leveraged households at impressive rates. This helped them compensate for the loss in trading income as stock markets sagged and improve the quality of their earnings. As profit levels are restored, more and more well-known international foreign investment houses came to recognize their superior earnings potential and issued buy or overweight recommendations. These bullish recommendations attracted more foreign investors, putting their equity stakes in some local banks at historically high levels. Encouraged by better-than-expected earnings performance in 2003 and a repeat in the first couple of quarters of 2004, foreign analysts and institutional buyers have been more receptive to the guidance provided by the top management of the major Greek banks. The increased confidence in the ability of local banks to meet and even exceed earnings targets explains why Greek bank shares are trading at a premium on well-known multiples, such as the price-to-earnings ratio, compared to most of their European peers. It is noted that UBS expects the five large local banks to produce average earnings per share growth (EPS) of 28.5 percent this year and 25.2 percent next, putting the Greek banking sector in ninth place among 40 countries in 2004 and in seventh position in 2005. Even though local banks have managed to contain operating cost growth, it is known that their success has been mainly revenue driven. With GDP growth expected to slow to 3.0-3.5 percent next year from 3.7-4.0 percent this year based on consensus estimates and local households becoming less under-leveraged, it is reasonable to anticipate a slowdown in retail lending which is likely to put an end to spread peaking. Although some major banks, such as National Bank, EFG Eurobank, Alpha Bank and Commercial Bank, have launched voluntary retirement schemes in a bid to overcome rigid labor market regulation and generate some cost savings in the years ahead, it is unlikely these schemes will have the kind of impact on costs required to compensate for revenue fatigue and sustain above-EU average earnings growth in the future. Investment banking, asset management and bankassurance hold some promise but do little to decrease earnings volatility, especially the market-dependent activities. This makes it imperative for Greek banks to look elsewhere for long-term growth opportunities, and nothing seems more natural than the underdeveloped, under-leveraged markets of neighboring countries, including Turkey. Of course, Greek banks can be present in the major EU and US financial centers, although their small size compared to international standards, their lack of a comparative advantage in know-how and the lack of a dominant position of Greek corporations in these mature markets makes the case for expansion there very weak. On the other hand, the case for Greek banks expanding further in the neighboring countries, including Turkey, and even Russia is quite strong. With a population of some 50 million people even excluding Turkey’s and a much lower GDP per capita, only 10 percent to 20 percent that of Greece’s, these countries collectively represent a potential source of revenue for Greek banks. The fact that Greek banks were among the first to invest in the financial sectors of some of these countries in the second part of the 1990s as they followed their local corporate clients into these markets gives them an edge. It is noted that all five major banks have some kind of presence in the markets of the neighboring countries with National Bank of Greece and EFG Eurobank having the largest, followed by Alpha Bank. National Bank controls UBB, Bulgaria’s second-largest bank, Stopanska, the Former Yugoslav Republic of Macedonia (FYROM)’s largest bank and has established its presence in other neighboring countries as well. National Bank is reportedly looking for opportunities in Turkey. EFG Eurobank Ergasias controls Post Bank, one of Bulgaria’s four largest banks and Banc Post, Romania’s third-largest bank, and has established a presence in other markets as well. Alpha Bank is also present in Albania, Bulgaria, Romania, FYROM and Cyprus. Although these markets entail risks, they also offer great opportunities since these economies are under-leveraged, with loans accounting for less than 20 percent of GDP, and an underdeveloped banking sector. In addition, like Greece in the past, they can generate a great deal of profits from other activities such as treasury and payments given the low level of competition. It is true that it may be too late to go into some of these markets at this point because the major banks have been privatized and the acquisition cost of major equity stakes in the remaining ones may be too large to justify such a move, given the uncertainties pertaining to the regulatory framework and macroeconomic performance. Nevertheless, one should not underestimate the fact that some of these countries will join the EU in a few years and experience in the case of Greece has shown that convergence has been a great catalyst for initiating structural changes and macroeconomic improvement. Greek banks have no choice but to consolidate their position and enhance their presence in the under-leveraged markets of the neighboring countries to convince investors of their long-term growth potential. Even if this requires taking some additional risks, the choice should be clear: Deploy and redeploy more resources into these underdeveloped markets for a handsome future payoff.