What's Wrong With Greek Banks and How It Can Be Fixed

(Bloomberg) -- Burdened by the highest ratio of bad loans in Europe, Greek banks have no shortage of challenges. And that was before Greece -- the continent’s most indebted state -- decided to end its bailout program in August without requesting a follow-up lifeline backed by European creditors. If doubts about the state of their balance sheets aren’t addressed, concerns about the fate of Greek banks could spiral out of control. That became clear this week when banking shares plunged, though news that the government is weighing plans to help lenders speed up bad-loan disposals arrested the declines.

1. Didn’t the world already fix Greece?

It’s tried. This summer Greece graduated from its third international rescue program and reached a landmark deal with Europe’s other governments that gives it a decade or more to start repaying most of its loans (with the understanding it won’t go back to the spending that brought its economy to the brink of collapse in 2009). The nation’s largest banks have been recapitalized three times since the start of the debt crisis -- most recently in 2015. The state, which has chipped in almost 50 billion euros to shore up capital over the past decade, says its banks are now well-capitalized and poised to gain from a nascent economic rebound. It also says that the banks have now new tools at their disposal to resolve the bad loans issue, including easier out-of-court settlement procedures and e-auctions.

2. Then what’s the problem?

Non-performing exposures constitute about 50 percent of Greek banks’ assets -- more than any other country in the European Union. And most of their regulatory capital consists of deferred tax claims against the battered Greek sovereign. The Athens Stock Exchange Banks Index has lost more than a third of its value this year, and Greece’s second-biggest bank, Piraeus Bank SA, has been asked to raise more capital via subordinated sales by year’s end -- a task complicated by its junk rating. The bank has said that it “monitors the debt capital markets to identify the right timing,” and that “such issuance remains subject to market conditions.” At the same time, lenders are being pressed by supervisors to speed up the cleaning up of their balance sheets and reduce the mountain of bad loans, with some analysts doubting that these ambitious targets can be achieved. Funds with short positions on Greek banks, such as Oceanwood Capital Mgmt LLP, aren’t convinced that the lenders can clean up their books without burning substantial capital.

3. What can be done?

The Greek government is said to be weighing a plan to help banks speed up their bad-loan disposals, possibly including a government guarantee, in a bid to restore confidence. The government could use a post-bailout cash buffer of about 24 billion euros to shore up the banks. Various ideas, including the creation of an Asset Protection Scheme and Special Purpose Vehicles on which bad loans will be unloaded with state guarantees, have been floated. But use of buffer funds could be a blow to government efforts to reassure investors that the state’s financing needs are fully covered for the years ahead. And it could run against European Union rules that forbid state aid to financial institutions without first a demand that private creditors, including those with deposits over 100,000 euros, take a hit.

4. How did we get here?

The downward spiral for Greek banks started a decade ago, when the country entered the longest and steepest recession in living memory. Bank clients -- corporates and householders -- have been defaulting on their loans en masse since 2008. During this period, the state also went bust, meaning banks had to take write-offs on the Greek bonds they held. Financing lines also dried up. And that was all before Prime Minister Alexis Tsipras was elected in 2015 on a promise to end austerity. His six-month clash with the country’s European creditors sparked a run on deposits and pushed Greece to the brink of leaving the euro area. Capital controls were imposed, and the economy went into a double dip recession, putting an abrupt end to a brief spell of recovery in 2014.

5. Are the banks blameless?

No. The nation’s financial struggles have exposed a series of failures in corporate governance, including loans extended to borrowers that couldn’t ever possibly repay. These practices were kept under wraps, not least because of vast loans extended to political parties and media companies. In fact, one condition attached to Greece’s most recent international bailout was a complete overhaul of banks’ boards. The question is whether new management can change the situation, or whether banks are too deep in the red to be salvaged.

6. So now what?

In previous cases where financial stability was at stake (e.g. Italy, Cyprus), European regulators and supervisors took a liberal approach to the EU’s state-aid rules, allowing public backstops to be used in order to avert disaster. But if such solutions are needed, they won’t be easy or cheap: Salvaging Cyprus’s Central Cooperative Bank earlier this year cost Cypriot taxpayers an amount equal to some 13 percent of the country’s economic output. In addition to potentially depleting funds originally intended as a cushion for the Greek state, using public money also raises questions about the credibility of the bloc’s banking rules, and the quality of financial supervision. After all, Greek banks are not the first ones to run into trouble after clearing a European stress test.

The Reference Shelf

• A QuickTake explainer on Greece’s financial odyssey.
• A Bloomberg story on reeling Greek bank stocks.
• More on the predicament facing Piraeus Bank.
• Greece has turned a corner, but its banks haven’t, Lionel Laurent writes in Bloomberg Opinion.

--With assistance from Marcus Bensasson.

To contact the reporters on this story: Nikos Chrysoloras in Brussels at nchrysoloras@bloomberg.net;Sotiris Nikas in Athens at snikas@bloomberg.net

To contact the editors responsible for this story: Vidya Root at vroot@bloomberg.net, Laurence Arnold, Dale Crofts

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