Local banks hoping for stress-free tests

The stress tests that Greek banks are due to undergo in the coming weeks will provide an important waypoint in the country’s efforts to get back on the path to normality. The parameters for the tests, which were outlined last week by the European Banking Authority (EBA), have provided some optimism that the beleaguered local lenders will be able to limp on toward better days without needing any significant injections of capital.

Greece’s creditors, particularly the International Monetary Fund, want to have a clear picture of what state the local banking system finds itself in before the end of the third program, thereby ensuring that no nasty surprises, such as the need for a new round of recapitalizations, will appear in the future. As a result, the stress tests will be carried out in Greece several months earlier than in the rest of Europe, with the results due to be published in May, about three months before the third bailout runs its course.

The EBA has set out baseline and adverse scenarios for the macroeconomic environment in which Greek banks will operate over the coming years. Its aim is to cover the full range of conditions and ensure that local lenders are adequately capitalized to deal with them. According to the EBA’s baseline scenario, Greece is expected to grow by 2.4 percent, 2.5 percent and 2.4 percent in the three years from 2018 to 2020. In the adverse scenario, the country’s gross domestic product is assumed to drop by 1.3 percent in 2018, 2.1 percent in 2019 and grow by 0.2 percent in 2020. In other words, there is a difference of 10.5 percentage points between the positive and negative outlook in GDP terms.

It is worth noting that the final 2018 budget approved by Parliament in December foresees growth of 2.5 percent this year. The European Commission also expects GDP to expand by this much in 2018, followed by 2.5 percent growth again in 2019 and a 2.3 percent expansion the following year, which is broadly in line with the parameters set by the EBA.

Executives at Greek banks are unlikely to have been concerned by the growth projections. Some analysts believe that these parameters would not lead to Greek banks needing any new capital after the inspections are concluded.

The trickier part comes when property prices are taken into account. In the EBA’s baseline scenario, home values are seen dropping by 0.5 percent this year and growing by 1 percent in 2020, whereas commercial real estate will grow by 0.3 percent each year to 2020. In the adverse scenario, the prices of residential and commercial properties are expected to drop by 17.4 percent compared to the baseline.

Apart from the fact that the Greek property market has been nosediving for the best part of a decade, the country’s banks are at the beginning of a process that will see the number of property foreclosures ramped up in an effort to deal with the huge pile of nonperforming loans on their books. Also, it is expected that the banks themselves will end up buying back many of the properties to ensure that the bottom does not fall out of the property market.

There have been suggestions that Greek bankers were expecting the adverse scenario regarding property prices to be a little less pronounced but when compared to other countries in similar positions, the assumptions put forward by the EBA do not look out of kilter. In Cyprus, for instance, residential prices are seen falling by 18.6 percent over the three-year period and commercial values plummeting by 22.7 percent. In Portugal, the respective drops are projected at 21.2 percent and 23.6 percent.

Those skeptical about the procedure, who feel the stress tests are too susceptible to political influence, might argue that the provisions given by the EBA are too benign for Greece’s case and the fragile recovery ahead. For example, the cumulative contraction of 3.2 percent over the next three years under the adverse scenario is less aggressive than in five of the last six stress tests that have been carried out.

Some feel that the process can be steered too easily to the result that those involved would want, which in this case would mean the Greek banks needing little or no new capital and Greece’s progress toward the completion of the bailout being relatively unfettered.

The IMF pushed last year for the stress tests to be backed up by an asset quality review (AQR), which it sees as being more thorough. European authorities resisted such calls, leaving some in doubt about how clear a picture the stress tests will provide.

“We view stress testing as an important step in assessing the adequacy of the current strategy for dealing with Greece’s exceptionally high level of nonperforming loans and assuring the soundness of the banking system,” IMF spokesman William Murray said during a press briefing last week.

“Beyond that, it’s a stress test that is done by the European authorities, not by us. I’ll leave it at that.”

The counterargument to those who doubt the efficacy of the tests is that Greece finds itself in a situation where its economy, and even property prices, have broadly stabilized and, given how far both have fallen in previous years, there is ample room for recovery. The low-base effect means that it will not take too much in the coming years to ensure some kind of progress, or to stave off another dramatic downturn.

Either way, the general expectation is that the Greek banks, which have suffered major knocks during the crisis, will be able to navigate the upcoming stress tests without taking any big hits. This will settle one of the final questions that have to be answered before the third bailout program expires, meaning that focus can turn to whether the income tax-free threshold will have to be lowered from 2019 rather than 2020, what form of post-bailout monitoring there will be and how Greece’s debt will be restructured.

It must be stressed, though, that this will not be end of the story for Greek banks, whose fate will continue to be tied to the overall course of the country’s economy. For starters, the local lenders have to reduce their stock of nonperforming exposure from just over 100 billion euros to less than 65 billion by the end of 2019. This process, rather than the stress tests, is likely to be the real challenge for Greek banks.