Greece Is Trapped

(Bloomberg Opinion) -- If you thought Greece's ordeal was over, think again.

Months after exiting its international rescue program, the country faces renewed trouble in its banking system. There is no easy fix: money is short and investor patience thin. But it looks increasingly like the gradual approach pursued by Athens and the euro zone authorities is running out of steam.

Lenders still bear the scars of a decade of economic crisis. Borrowers are failing to meet payments on almost half of all loans, the highest ratio in the euro zone. A large proportion of banks' capital is made of so-called “deferred tax assets” – future tax deductions accrued because of past losses – about which investors are skeptical.

True, there are differences in the health of the four largest lenders: Piraeus Bank SA is in the worst shape, while National Bank of Greece SA and Eurobank Ergasias SA are faring much better. But investors have little time for such subtleties: the country's banking stocks have trailed their European equivalents by 32 percent this year. Even Eurobank trades at an unhealthy 77 percent discount to the book value of its assets.

Regulators must hold some of the blame. In early 2018, the supervisory arm of the European Central Bank held a stress test specifically for Greek banks – and cleared them all. Only Piraeus had to take action, raising 500 million euros ($580 million) in subordinated debt. But, after market conditions worsened, it has yet to complete that offering.

So far, the ECB has championed a gradual approach, setting banks a series of targets for reducing their non-performing loans. The firms have largely complied – but the hardest part is still to come.

The ECB wants Greek banks to, on average, bring their gross ratio of non-performing loans to below 20 percent by the end of 2021. Analysts are skeptical that all will hit their targets, with Piraeus and Alpha seen as the most likely laggards. Any extra provisions will also dent their anemic profitability.

The Greek banking system needs a change of pace, or risks remaining vulnerable to any future crisis. The most urgent task is to stanch the bleeding at Piraeus, which has lost more than 60 percent of its market value this year. If the bank fails to issue new subordinated debt, it could breach its capital requirements, putting it a risk of resolution.

The government needs therefore to consider taking more drastic action in the form of a so-called precautionary recapitalization. This would force losses onto subordinated bondholders and cost the government money, but it would at least fix the weakest link in the system.

Athens should also be open to other solutions, too. One would entail setting up a bad bank onto which lenders could unload some of their impaired loans. The sales would have to occur at market price, something which would cause losses for individual banks. The Greek government would therefore need to commit a substantial amount of money both for the initial equity for the “bad bank” and to recapitalize lenders unable to replenish capital from the markets.

There are shortcomings to these solutions: The government has a cash buffer which could be used to finance a banking clean-up. But this money was set aside to give investors confidence that Greece would be able to ride out any brief market turbulence that stopped it from raising cash. Using it could risk reviving those investor concerns. 

Furthermore, any kind of public intervention would increase the role of the state in the banking system. Private investors would also suffer important losses: Since this would not be the first time, many of them could choose to leave Greece for good.

Even so, the gradual approach looks set to only delay the inevitable. Unlike Italy, where the banking crisis was largely confined to some lenders, all Greek banks are suffering from the enormous consequences of the recession. That means a break with the past – and, if required, an injection of public capital and a more flexible use of the European Commission's state aid rules – is necessary. Only then then might investors be attracted back to the country's financial system.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

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