Greek banks need to take urgent measures to protect their liquidity in the wake of the sovereign debt crisis, but must be careful not to destabilise the fragile economy further by cutting off credit to their clients.

All categories of Greek borrowers today are struggling to find liquidity to deal with their increasing economic responsibilities. Greek credit institutions are implementing stricter lending criteria for loans and, even when they do lend, the cost for their clients is considered high. The banks justify their stance by claiming that they fear a future increase in non-performing loans in their portfolio, and face difficulties raising cheap liquidity for themselves, due to distrust of Greek assets in the international money and capital markets.

As deposits are stable or even declining, banks need to take active measures to raise liquidity. According to the financial statements published by the 19 Greek commercial banking groups (on a consolidated basis), customer deposits decreased by €15.9bn from June 2009 to June 2010. Most of this reduction took place in the first half of 2010.

Of course, Greek banks had the capacity to raise cheap liquidity before the considerable downgrading of Greece's sovereign debt rating in 2010, and also from the European Central Bank (ECB) repo programme throughout 2009. However, although the ECB programme was extended to January 2011 (albeit at a considerably higher cost), Greek banks were asked to amortise or commercially refinance a big part of their total debt to the ECB - approximately €96bn - during 2010. In addition, Greek commercial banks are urged to repay by the middle of next year the financial support that was granted to them by the state at the peak of the global financial crisis in late 2008 and early 2009 - this totalled €28bn.

Moreover, high spreads between Greek government bond yields and the respective German ones are having a great impact on the cost of servicing and refinancing the public debt. Greek banks in turn borrow funds at a higher cost compared with the state and transfer the higher cost of lending to businesses and households. In addition, Greek banks own approximately 20% of the total outstanding amount of the bonds issued by the Greek state. This has a negative impact on the rating of Greek banks, aggravated by deterioration in their asset quality resulting from the recession. Moreover, the downgrading of Greek sovereign debt rating may also affect the rating of securitisation and covered bond issues.

Nikolaos Georgikopoulos

Nikolaos Georgikopoulos, Observer on the committee on financial markets at the Organisation of Economic Co-operation and Development

Staying open for business

In periods of economic recession, credit risks increase and credit institutions restrict, in principle, credit growth, which exacerbates the recession. Greek banks need to fully appraise the risks that are inherent in new loan applications from their clients, but in a way that will ensure that they do not put too much pressure on the markets. Instead of immediately rejecting all applications that do not appear attractive at first sight due to the implementation of stricter models for credit assessment, they could disburse a percentage of new loans requested, at a higher interest rate depending on the degree of riskiness of the borrower, and possibly with a longer maturity.

The percentage of refinanced loans, which could possibly be classified as 'at risk' due to the weak economic activity that is expected, could also be increased. In addition, banks could modify the contractual terms of certain older loan agreements in order to relieve their borrowers - helping to shield clients from the economic recession that is drastically restricting their incomes, as well as helping to avoid classifying the loans as non-performing.

Due to the deterioration in the macroeconomic environment and restricted access to the financial markets, mergers and acquisitions (M&A) also constitute a useful tool for banking groups. They can contribute to the stability of the financial system, to the enhancement of liquidity and to the favourable change of the investment climate, all of which will result in the gradual reopening of the interbank markets. In the case of Greece, it is also possible to achieve considerable economies of scale through mergers.

At this point, it should be noted that the retail banking networks of several Greek bank groups overlap in terms of geography. This means that operating costs could be drastically reduced in a potential merger, mainly due to the abolition of duplicated branches. Alternatively, the reallocation of excess network to areas of Greece where the merging groups have no existing presence would help their further expansion. Consequently, the banks could avoid a drastic reduction in their personnel, especially at such a critical time for the Greek labour market.

In the framework of restructuring the Greek financial system, achieving the necessary stability but also ensuring the required liquidity, banks should also increase their own funds. This would help to avoid resorting to the safety net of the International Monetary Fund's Financial Stability Fund (€10bn). Consequently, share capital increases and M&A for Greek credit institutions seem unavoidable in the coming period, especially in the case of those with a low grade in the recent EU stress-testing exercises.

Nikolaos Georgikopoulos is an observer on the committee on financial markets at the Organisation of Economic Co-operation and Development, and a research fellow at the Centre of Planning and Economic Research in Athens

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