Cutting links to the state may be the solution for banks that can lead to growth

The success of the Greek economic policy program in restoring fiscal sustainability and winning over the confidence of investors in capital markets relies on putting the economy back onto a growth path. However, the chances of doing so will be small as long as the banking sector cannot delink from the state and its fiscal mess. The latter requires some bold moves. The argument of equal treatment with Ireland may help Greece get what it wanted all along from its official lenders, namely, the eurozone countries and the International Monetary Fund, in the last few months. That is, the extension of the repayment of the 110-billion-euro financing package which supported the program agreed to with the European Commission, the European Central Bank and the IMF last May. The Greeks would have liked the extension of the repayment schedule to be presented as a reward for honoring the tough commitments undertaken in the memorandum signed last May. They may get some praise in the official communique of the EU ministers after all but it is clear that they owe much more to Ireland and the prevalence of common sense. Of course, the country would not be in such a position if it had managed to negotiate a better deal with the so-called «troika» last May as the latter was more keen in anticipating the market reaction to the resulting annual borrowing needs of the country in excess of 70 billion euro in 2014-2015. It would have required an impressive fiscal consolidation, ample liquidity in global markets and a risk-loving international financial environment to convince global investors to buy Greece’s new bonds at reasonable yields in 2011-2012, and to overlook its high public debt-to-GDP ratio and large borrowing needs in coming years. Although extending the repayment of the remaining official loan makes it easier for the country to refinance its public debt in coming years, the odds are still against it. Standard & Poor’s, one of the major credit rating agencies, warned last week against another downgrade of Greece’s rating, which is already at junk status, depending on the rules governing the new mechanism for dealing with sovereign crises after 2013 sought by Germany. Even so Greece’s ability to service its public debt in the future depends to a large extent on putting its economy back on a growth trajectory. But the Greek economy is not likely to grow again at satisfactory levels if its banking sector does not function properly and provide credit to creditworthy households and corporations. Greek government officials and bankers are always quick to point out the strengths of the banking sector, which is not the cause of the country’s problems, unlike in Ireland. They say local banks were not exposed to toxic assets such as subprime loans abroad and there was no real estate bubble in Greece. They also point to the Pan-European bank stress tests last summer, where just one bank, ATE Bank, did not pass. This is true to a large extent as local banks have been victims of the state’s sovereign crisis and have been unable to play their intermediary role in a proper way. With capital markets closed for quite some time and deposits depleting by more than 10 percent since the start of the year, they have relied on the ECB’s cheap financing to continue funding the economy and roll-over their maturing bonds. Many analysts say Greek banks will get back to business as usual when the state is able to access the capital markets again. However, this may take some time, most likely years, and banks will not be able to help the economy get back to growth and the to state put its public finances faster in order. Some therefore suggest that local banks delink from the state as soon as possible to be able to attract much needed capital and finance the economy without relying on the ECB. The only way to do so is to recognize the losses from the Greek government bonds they carry on their books. With local banks carrying some 35-40 billion euros of Greek bonds at prices well above those found in thin secondary bond markets, this would entail heavy losses for their current shareholders. The latter could either participate in recapitalizing their banks or sell them at a cheap price to foreign peers. One may say that nobody can force private shareholders to sell their equity stakes and may be right under normal circumstances. However, these are quite unusual circumstances and the case of Ireland has shown how much leverage the ECB has over the state and the banks, since it is their lifeline. Perhaps, Ireland would not have sought financial help if it were not for the insistence of the ECB, as its Justice Minister revealed in an interview. There is no question that Greek banks will have to clean up their balance sheets to convince investors to trust them again and provide them with fresh capital to be able to provide credit to the local economy. This requires cutting their major link to the public sector, namely selling all or a great deal of Greek government bonds in their portfolios and recognizing the losses. Some even suggest that they replace some of them with the new AAA rated securities to be issued by the EFSF (European Financial Stability Mechanism), the aid mechanism to be tapped by Ireland. It is not a panacea but it may be a solution to getting the Greek economy back to work.

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