Athens may face a choice: Bail-out or bail-in?

The government is under pressure from special-interest groups, such as farmers, to succumb to their demands on one hand, and the country’s creditors to reach a comprehensive agreement on fiscal issues and pension reform on the other. However, the deteriorating economic climate and the lack of substantial progress in tackling non-performing loans (NPLs) points to a more difficult choice down the road: Depositors or borrowers?

Undoubtedly, the protesting farmers have stolen the limelight lately as they paraded through Athens in a bid to secure most of their tax and pension advantages before they return to their farms in March. The course of the negotiations between the government and the technical teams of the lenders is the second hottest issue in town, with Poul Thomsen adding fuel to the fire by clarifying the IMF’s position on the matter.

A relatively smaller number of people paid attention to the shares of Greek banks which have been hammered since the start of the year. Their drop is widely attributed to concerns about the health of the banking sector in Europe and specific Greek issues, such as the first review of the third economic program and the rising political risk. As a result of the drop, the shareholders who participated in last year’s share capital increases, are suffering huge losses.

However, there are other implications as well. Greek individuals and entities are among the shareholders who seem to have taken loans from local banks to join in last year’s recapitalization. There is no official estimate but pundits put the total amount at several hundred million euros. This is not a negligible amount and there is a significant risk these loans will become NPLs in the next few quarters as the value of the collateral, namely shares, plummets.

We remind that business plans, on which the assessment of restructured corporate loans was based in last year’s AQR (Asset Quality Review) test, run the risk of becoming outdated as the economic situation changes and little is being done, at least so far. This means a reassessment of these loans could hide some nasty surprises. This brings up the issue of NPLs once again and the fact that the finalization of the implementation framework for loans secured by the primary residences as well as loans of SMEs and consumers is still pending.

Of course, one may argue, following the recapitalization of the banks last year, their capital position is comfortable, serving as a mitigating factor against asset quality risk. This is true but one should also bear in mind a relatively large portion of their capital, ranging from 40 to 70 percent depending on the bank, is made up of Deferred Tax Credits (DTC), a weak form of capital.

Including the DTCs, some analysts estimate that banks can cope with a double digit percentage point increase in bad loans and a similar increase in the coverage ratio in the next three years. The coverage ratio, which refers to the portion of the loans covered by money set aside by the banks, namely provisions, to cover potential losses, is estimated at less than 60 percent on average. The NPL ratio averaged around 34 percent of total loans.

Although it looks as if local banks have a comfortable capital buffer at this point, this could change very rapidly if there is no swift action on NPLs resolution, as the implications from the sharp drop in Greek bank shares remind. This is more so because of the new law governing the recapitalization of banks, which came into effect on January 1. If there is a need for another recap down the road, it will not be the taxpayers (bail-out) but the banks’ shareholders, the bondholders and the depositors (bail-in), who will foot the bill.

One can better understand the implications by just looking at the fall of Italian bank shares on concerns about the application of the bail-in. It is reminded that Greek banks have minimal bond holdings after last year’s recap and therefore it will be the shareholders and the depositors who will feel the pinch if it comes down to that.

If the authorities and the banks do not move fast to tackle the NPL issue, they will be confronted with a worse dilemma later on: choosing between a bail-in and depositors on one hand, and the borrowers, including strategic defaulters, on the other. This will be a much more serious challenge for the government than standing up to the farmers and other vested interests.

[Kathimerini English Edition]