The majority of Greek banks appear to share the view that they are suffering the consequences of the severe economic and debt crisis and that everything, or at least almost everything, will go back to normal once the crisis fades away. In so doing, most of them fail to see the need to change their strategy and business model to fit the new landscape. It has been said repeatedly, and rightly so, that unlike Ireland, where irresponsible decisions made by the country’s major banks undermined the health of the national economy, in Greece it was the public sector which created the problem and consequently undermined the banking sector. The recession, which is entering its third straight year, has lowered living standards through higher unemployment and lower real incomes and is to a large extent the result of restrictive fiscal and incomes policies aimed at slashing the budget deficit as a percentage of gross domestic product to help stabilize the public debt-to-GDP ratio down the road. The protracted contraction of economic activity in Greece is bound to make things worse before they get better, pushing nonperforming loans to more than 14 percent of total loans (NPL ratio) in 2011 and perhaps even further up in 2012 as clients are unable to pay their loan installments. Of course the NPL ratio could have been even higher if the so-called «loan adjustments» – mainly comprising lengthening the maturity of loans to give clients some breathing space – were taken into account. Even so, the banks will have to continue taking high provisions and write off some loans to boost the credit quality of their portfolios at the same time the risk of falling real estate prices may put more burden on their capital requirement, as we pointed out last week. The rise in NPLs is not the only result of largely state-induced economic policies. The heightened sovereign risk and the potential write-downs from some form of public debt rescheduling means Greek banks will have to raise significant amounts of capital to comply with stricter capital adequacy ratios. Piraeus Bank was the latest to raise 800 million euros in capital via a rights issue, with National Bank of Greece having already done so and preparing for more by selling a minority stake in its Turkish subsidiary. Eurobank has also sought to boost capital via the sale of a strategic stake in its Polish subsidiary. The high likelihood of a debt default, as perceived by investors, has raised questions about the banking sector’s solvency and liquidity. With local banks most likely shut out of the wholesale markets in 2011 and retail deposits weak, ECB funding will be once again the main and perhaps only source of funding. It is clear that the worsening macroeconomic environment and concerns about the sovereign risk constitute a major burden on Greek banks. So it is normal to assume that they will regain part of their strength when the economy gets out of its slump and fears of a severe form of debt restructuring subside, opening the way for banks to have access to some form of decent funding from the repo and wholesale capital markets. However, it looks as if a good number of bankers believe things will get back to normal more or less when the macroeconomic environment improves and the situation on the public debt front stabilizes. This means they believe the old strategy of asset growth can work again with some adjustments made along the way. However, this is wrong. Greek banks will need a new strategy underpinned by a new business model in the new landscape of most likely lower economic growth at home and more expensive credit. The strategy of giving loans handily was facilitated by the fact that liquidity was ample and cheap in the last decade. It was also underpinned by the assumption that the public sector was creditworthy and private companies doing business with the state were safe. In other words, a «haircut» in such loans was not assigned even a low probability. This strategy also did not take into account the fact the local economy could suffer from a protracted recession accompanied by high unemployment and lower incomes. We all know by now that almost all of these assumptions were wrong. So Greek banks cannot keep on betting they will find the money to fund the expansion of their assets, either loans, bonds or bank acquisitions abroad. All this boils down to the need for a new strategy of downsizing, but to design and implement it they will first have to recognize the problem and admit that even if the state manages to put its house in order and the macro picture improves they will have to change their strategy and business model. The sooner they get it the better.