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14 June 2011

WSJ: Banks are Greece's Achilles' heel


Even if Greece gets its second bailout and avoids default, its problems are far from over. The key vulnerability is the banking system; the immediate challenge is liquidity and whether the banks have sufficient funding to support a recovery.

Sure, bank capital is a worry. The average core Tier 1 capital ratio for the five major lenders is about 9%. That may not be adequate to absorb a future reduction in value, or haircut, to Greek government bonds. Gross exposure to government bonds varies between 72% of equity at Marfin Popular Bank and 218% at National Bank of Greece. If the value of all outstanding government bonds was cut by 40% in 2013, Greek banks will need a combined €8.4bn to hit an 8% core Tier 1 ratio on a Basel III basis, according to UBS.

But these remain theoretical concerns for the time being. The eurozone appears to have no appetite to impose haircuts at this stage. The more immediate concern is bank funding. The Greek banking system has a relatively low loan-to-deposit ratio of about 120%, well below Irish and Portuguese levels. But over the last year, deposits have fallen by €44bn, and Greek banks have been shut out of the repo market, the interbank market and bond markets. That has left a €135bn funding gap, mostly filled by the European Central Bank.

In theory, Greek banks have access to unlimited ECB liquidity. But in practice, they are under pressure to reduce their dependence. They already have cut borrowing this year by €11bn, to €87bn, despite a €13bn deposit outflow. Thanks to a combination of falling consumer-loan demand and the disposal of nearly €40bn in noncore assets, they have been able to deleverage without cutting business lending.

But the scope for further painless deleveraging may be limited. Forcing banks to sell foreign subsidiaries would free up liquidity but risks depriving banks of profits needed to offset domestic impairments. More important, consolidation of the fragmented bank market could deliver huge cost savings, which would boost profits and capital, helping to revive market confidence. But progress has been negligible. National Bank of Greece's takeover bid for Alpha Bank last year was rejected, and there are no other deals on the table.

As a result, the situation is precariously balanced. The banks have enough liquidity for now. But there's little capacity to boost lending, borrowing costs are high, and any further deposit flight risks triggering a credit crunch.

Unless the ECB is prepared to be generous, Greece may struggle to expand its way out of trouble, and those considering further bailouts may find they are throwing good money after bad.

Full article (subscription needed)



© Wall Street Journal


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