Greek banks, unlike their counterparts in other Western countries, were not the cause of the recession. Even though they are suffering the consequences of the worst economic slump since the 1970s, they seem to have devised a strategy to help themselves and the national economy recover by pinning their hopes on borrowing more extensively in the interbank market. However, is this feasible given the cost? There is no doubt that the economy’s fiscal performance will be a catalyst for the country’s ability to tap international bond markets again at some point in 2011 or in the first quarter of 2012. Despite an expected sharp revision in the budget deficit and public debt as a percentage of gross domestic product in 2009 to more than 15.1 percent and 125 percent respectively, the government still seems to be aiming at a deficit around 8.1 percent of GDP this year and close to 7 percent in 2011. The ability of the state to deliver on the budget deficit targets set in the memorandum signed with the European Union and the International Monetary Fund will also play a key role in Greek banks’ efforts to further boost their liquidity via sales of covered bonds and even senior bonds at some point. ECB reliance It is noted that local banks have relied heavily on the European Central Bank to refinance their needs, buy government bonds and provide loans to the private sector over the last two years. Greek banks had borrowed about 95 billion euros from the ECB at the end of September by providing collateral in the form of bonds, other securities and qualified loans worth about 137 billion euros. This is a cheap form of borrowing which has enabled them to boost their net interest margin and help their bottom line during these difficult times. The ECB will tighten up the rules by making this form of funding more expensive for banks, starting in 2011, but it has obviously no plan to pull the rug from under the feet of Greek or other eurozone banks as the lender of last resort. Still, banks fully understand that they have to reduce their reliance on ECB funding to please the major credit rating agencies and even international institutional investors who view it as a liability. But they fully understand they have to open up the interbank market, where one bank lends to the other, to be able do so before the Greek state is able to borrow on international bond markets. They understand this is a gradual process and may take some time before other banks are willing to lend them sizable sums in the interbank market. National Bank of Greece (NBG), the country’s largest lender, has taken the first step by beefing up its equity capital by about 1.8 billion euros recently and planning to further boost it by at least 1 billion euros via the sale of a 20 percent equity stake in Turkish subsidiary Finansbank. The goal is for NBG to be an overcapitalized bank so the counterparties in an interbank transaction feel more comfortable to lend to it. The strategy looks set to be working as National Bank’s CEO Apostolos Tamvakakis appears to have reached an agreement with large foreign banks to provide credit lines of up to 3 billion euros to his bank, following the successful completion of the recent share capital increase. Of course, things would become much easier for NBG if one or more credit rating agencies revised its ratings upward in the first quarter of 2011. Analysts think other Greek banks will follow the same route sooner rather than later. However, it was Eurobank EFG which entered into a two-year repo agreement with Nomura to borrow 300 million euros recently by posting collateral Greek government for the first time since January. It is noted that foreign banks were willing to lend money to local banks on the interbank market if provided with collateral bonds from other countries or even major corporations but not Greek state bonds. This is because they were afraid Greece could go belly up. Despite the above positive developments, it is too early to talk about opening up the interbank market for Greek banks when putting Greek government bonds up as collateral. This is the case because the cost of doing so appears to be high at this point. According to various market sources, foreign banks accept Greek state bonds as collateral to provide liquidity only if the local bank accepts a sizable haircut to the market value of the bonds. In other words, a bond expiring in 2030 with a nominal value of 100 which is trading at 60 on the market is usually accepted as collateral only after a haircut, bringing the cost of acquisition to the foreign bank to around 40-50. Most foreign banks do so because they obviously think the recovery value of Greek bonds if the country defaults will be around this range. So, if everything goes well they stand to make lots of money from these repo transactions. So, Greek banks may want to reduce their dependency on the ECB in the months ahead but this will be costly if they post state bonds as a collateral in interbank transactions. It is noted that the cost of ECB funding comes a little over 1 percent and state bonds are accepted with a small haircut, somewhere between 90 and 100 percent depending on the maturity of the bond so they get more cash in return.