Banks wary over credit growth prospects

Encouraging macroeconomic data from both sides of the Atlantic have helped developed markets brush aside worries about the quality of corporate profits and new potential earnings downgrades and have restored confidence in the beginnings of global economic recovery. Comments by Fed’s Chairman Alan Greenspan and European Central Bank’s President Wim Duisenberg made last week also reinforced the notion that economic recovery in the US and the EU is under way. If that’s the case, then it is reasonable to believe that the Federal Reserve and the ECB will adopt tighter monetary policies and jack up their short-term interest rates at some point later this year. Although a pickup in economic growth is welcome, its offspring, that is higher euro interest rates, is clearly not. Greek banks counting on the growth of retail banking activities should not be pleased by the prospect of higher euro rates later in 2002. Battered by steep declines in commission income and trading profits due to poor capital market conditions, Greek commercial banks turned to retail banking activities to boost their income in the last two years. This strategy paid off to a large extent, as impressive loan growth coupled with high net interest margins helped them cushion the negative impact from their other capital market activities. Indeed, last year’s results, although disappointing, depict this trend. Figures show that the net interest income of Greece’s six largest banks – National Bank, Alpha Bank, EFG Eurobank, Commercial Bank, Piraeus Bank and Agricultural Bank – grew by more than 27 percent year-on-year in 2001, boosted by a pickup in outstanding loans and declining euro interest rates. The positive carry of the bond portfolios, that is the difference between coupon interest earned on bonds and lower funding rates, also contributed; but only in the financial results of the banks published under Greek GAAP. Interest income earned on bond portfolios is included in total interest income under Greek GAAP but not under IAS (International Accounting Standards) or the US GAAP. At the same time, though, commission income and earnings from financial transactions fell sharply. Although nobody disputes the income potential that the combination of a low penetration of financial services and a fast-growing national economy offers to local banks, many analysts are concerned about the impact of tighter monetary policy on Greek banks. Indeed the monetary easing of 2001, which enabled most large local banks to take advantage of ECB’s rate cuts and widen the interest rate spread between loans and deposits to their benefit, may be a thing of the past if current market expectations are right. A number of analysts believe that higher euro rates will have an adverse effect on loan growth and net interest margins, the two pillars of interest income for local banks. They say rising euro rates will make it increasingly difficult to attract new customers or convince existing ones to assume more debt at the same time as their monthly installments go up, since the majority has taken out variable rate loans. This points to a slowdown in loan growth, which in turn may fuel more competition among banks for market share, especially in the high-margin category of consumer loans and mortgages. Stiffer competition, along with the inability of banks to fully pass higher interest rates to customers, will most likely lead to lower margins. The combination of slower loan growth and tighter interest rate spreads will inevitably lead to a deceleration in interest income and make the attainment of earnings consensus estimates more difficult unless the bruised Athens Stock Exchange come to the aid of Greek banks, which have the lion’s share in the major stock indexes. Even if euro interest rate hikes get delayed by the ECB – the most likely scenario – to ensure the sustainability of the economic recovery in the eurozone, bankers appear concerned about maintaining the high loan growth rates of 2000 and 2001 again this year. They already see signs of fatigue as the pool of borrowers does not seem to be growing fast, while other Greeks who have not borrowed seem to continue to resist taking out bank loans. These bankers agree things will get more complicated if the ECB starts raising interest rates later this year. The prospect of a tighter monetary policy does not bode well for local banks eager to increase exposure in retail banking. Higher euro rates may intensify competition sooner than expected and hurt interest income, their motor in the last couple of years. Although Greece’s relatively low loan-to-GDP ratio argues for great potential in this area, the path to a much higher ratio, closer to the EU average, may not be that smooth, especially if it is accompanied by a period of higher interest rates.