Greece: The PSI and the process of bank recapitalization (2012-2016)

24 January by Daniel Munevar

CC - Flickr - Azur_Medium

This section analyzes the impact of the debt restructuring of 2012 on Greek banks and the measures taken to ensure their proper recapitalization Recapitalization Reconstituting or increasing a company’s share capital to reinforce its equity after losses. When the banks were bailed out by the European States, they were most often recapitalized with no conditions attached and without the States having the decision-making power their participation in the banks’ capital should have given them. . It describes the role of the Hellenic Financial Stability Fund (HFSF) in this process and the problems derived from the composition of its governing council. This included former bankers, both Greek and foreign, who had been involved themselves in mismanagement of banks. As a result, the HFSF refrained from taking any significant measures that could upset the status quo of Greek banking. Furthermore, it shows how the policies imposed by the Troika Troika Troika: IMF, European Commission and European Central Bank, which together impose austerity measures through the conditions tied to loans to countries in difficulty.

as part of the first recapitalization process undermined the stability of the Greek banking system.

At the beginning of 2012 it became clear that the programme of financial assistance to Greece was off track. The implementation of austerity measures caused an economic collapse, which made the achievement of the fiscal targets of the program a self-defeating process. As a result, by the end of 2011 public debt had increased to €356 billion (172.1% of GDP GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
). This created a significant problem, as the fist programme was based on the assumption that starting in 2012 most of the funding needs of the country would be met by private financing. |1| However, Greece access to capital markets was all but blocked by the looming prospect of a debt restructuring. Thus, in addition of official funds to satisfy the financing needs of the country, measures were required to reduce the debt burden.

it became clear that the programme of financial assistance to Greece was off track

A second programme of financial assistance to Greece was arranged to this end. The new programme maintained the same internal contradiction of the previous one where high primary surpluses were supposed to be compatible with economic recovery. It also included the restructuring of Greek public debt under the so called the Private Sector Involvement (PSI). This envisioned a debt exchange with the remaining private creditors of the country in order to reduce its debt burden. As a result Greek banks were expected to play a key role in this process given their large exposure of government bonds. Thus, in order to ensure financial stability, the programme had to deal simultaneously with debt restructuring and its knock on effects over the solvency of banks.

The debt restructuring negotiations took place between March and April of 2012. It was the largest operation in the history of sovereign defaults, involving securities with a face value of €205 billion. |2| To accomplish it, the Greek government amended the conditions of bonds under Greek law with a face value of €177 billion. |3| In theory the government could have used this mechanism to unilaterally impose conditions on its creditors, but chose instead to negotiate with them by retroactively fitting the bonds with Collective Action Clauses (CAC). |4| With this instrument in place, the government reached an agreement to restructure public debt with 82.5% of the bondholders with claims under Greek law. |5| The CAC made this level of creditor participation a binding element over all the holders of domestic law claims to participate and accept the agreement. As a result of it, the nominal value of Greek debt was reduced by €107 billion, or nearly 50% of GDP.

However, the actual debt relief receive by Greece was less than this figure. This is explained by the uneven distribution of losses of the restructuring. Whereas pension funds Pension Fund
Pension Funds
Pension funds: investment funds that manage capitalized retirement schemes, they are funded by the employees of one or several companies paying-into the scheme which, often, is also partially funded by the employers. The objective is to pay the pensions of the employees that take part in the scheme. They manage very big amounts of money that are usually invested on the stock markets or financial markets.
and other domestic bondholders suffered losses of around 65% in the present value of their claims, banks were compensated in full through a mechanism of bank recapitalization. Thus, a large portion of the debt relief ended up being used to compensate the losses of banks. An amount of €40.5 billion was set-aside in the framework of the second programme to ensure that the capital needs of the main banks of the country were met. |6|

banks were compensated in full through a mechanism of bank recapitalization

Its important to highlight that as it was the case in the previous programme, no bail-in mechanism of shareholders and bondholders of the banks was contemplated as a way to reduce the need for public funds. The Greek government could have saved up to €25 billion of bailout funds had they decided to implement this type of measure. |7| This decision stands in stark contrast to the approach taken in the context of the second recapitalization scheme implemented in 2015 when government held shares were bailed in so as to reduce the use of bailout funds. The double standard applied by protecting private shareholders in 2012 but bailing in public shares in 2015 is highly questionable.

Furthermore, the recapitalization funds were provided to ensure that Greek banks could handle the impact of the debt restructuring as well as their rapidly deteriorating loan portfolio. In theory, a proper level of capitalization would allow them to recognize their losses and clean their balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. sheets so as to be able to start providing credit back to the economy and jumpstart economic recovery. In this regard, a solid framework to deal with the problems of non-performing loans (NPLs) should have included among others, measures aimed at making changes in management personal and business models. However, the programme limited itself to superficial measures such as addressing future changes in the legal framework so as to facilitate, among others, maximization of asset Asset Something belonging to an individual or a business that has value or the power to earn money (FT). The opposite of assets are liabilities, that is the part of the balance sheet reflecting a company’s resources (the capital contributed by the partners, provisions for contingencies and charges, as well as the outstanding debts). recovery. |8|

The lack of a solid framework to deal with NPLs can be partially explained by the explicit assumption used by the regulators regarding the impact of the second programme on the economy, and by extension on the evolution of the loan portfolio of banks. The programme assumed a large contraction of the economy in 2012 to be followed by a quick recovery starting 2014. The revival of income and employment would then allow the banks to stabilize and eventually put under control the growth of bad loans. |9| However, as these projections de facto dismissed the multiplier effects of the fiscal retrenchment included in the program, they were off by a significant margin. |10| As the economic depression continued in Greece, NPLs continued to increase unabated (figure 1). |11| Thus, even though the bank recapitalization exercise had been completed less than 18 months before, NPLs represented 138% of the banks capital by the end of 2013. |12| To bail out the banks without facilitating economic recovery and recognizing the poor quality of the loan portfolio was to throw good money after bad.

Figure 1 – Greece, evolution of NPLs as % of total loans, 2009 – 2015

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Source: IMF

Overseeing the process of bank recapitalization was the Hellenic Financial Stability Fund (HFSF). The HFSF was setup in 2010 to ensure the stability of the Greek banking system. Its responsibilities include, among others, the provision of capital to credit institutions, monitoring and supervising the fulfillment of restructuring plans submitted by credit institutions that have received resources from the fund, as well as facilitating the management of non-performing loans. |13| The fund, which was set up as an independent body from the government, had a slow start. During the first year and half after its creation, the HFSF had capital for €1.5 billion. During this time the only bank receiving funds from it was New Proton. |14| Given the particular characteristics of the relationship between the HFSF and New Proton, this is a topic to which this report will return.

Once the second programme became effective, the scale of operations of the HFSF increased dramatically. The fund was allocated with €50 billion of bailout funds which were to be used in the recapitalization of banks affected by the debt restructuring. As part of this process, its independence from public control was strengthened. Despite the fact that the HFSF was to acquire a significant participation in banks as a result of the recapitalization process, |15| the programme placed strict limitations on the voting rights associated with the shares of the banks in its possession. The objective of such measures was to ensure the business autonomy of the banks both dejure and defacto. |16| Thus even though the recapitalization was done with public funds, the actual control by the Greek Government over the resources and the benefited institutions was severely limited. The programme implicitly excluded the possibility of public or cooperative ownership of the recapitalized institutions, as it was successfully used, for example, in the cases of Norway and Sweden in the early nineties. |17|

The programme implicitly excluded the possibility of public or cooperative ownership of the recapitalized institutions

As the independence of the General Council of the HFSF was strengthened, some serious questions were raised regarding its composition. The government and the Troika faced a difficult choice in terms of the selection of its members. On the one hand, to rely on Greek-only members was problematic given the extensive allegations of corruption and collusion in Greek banking. On the other to rely on foreign members only would be perceived as an unjustified outreach by the Troika. |18| In the end, by bringing foreign members with a questionable background the worst combination of both options was chosen. For example, the Council counted among its members with Pierre Mariani and Wouter Devriendt. Both people were involved in the badly managed process of resolution of the Dexia Group in Belgium.

Even worse is the case of Anastasia Sakellariou, Chief Executive Director of the HFSF between 2013 and 2015. Sakellariou had to be asked by the Greek government to step down from its position in May of 2015 as she was charged, alongside other 25 former executives of the Hellenic Post Bank, with committing fraud and money laundering. |19| The specific charges against Ms. Sakellariou relate to the approval in 2012 of a loan to refinance two credit lines of the bank to a well-known local magnate. |20| Instead of asking for her removal until the investigation had concluded, both the Director of the Bank of Greece, Yannis Stournaras, as well as the board of the HFSF, supported Ms. Sakellariou. |21| This story helps to understand why it has been so difficult to tackle NPLs in the system: its not possible to expect a positive outcome when the authorities in charge of regulating banks and forcing the recognition of losses have been themselves involved in the carrousel of banking corruption. Without strong measures to restructure the banks, including a complete makeover of boards and management as a way to tackle corruption, the problems derived from bad loans will continue to plague the financial institutions of the country.

Examples of this dynamic can be observed in the handling by the HFSF of the problems faced by two Greek banks, Proton and Piraeus. In the case of Proton, the management of the bank was changed in 2010 after Mr. Lavrentis Lavrentiadis bought a minority stake in the bank. The director of the Bank of Greece, George Provopolous, personally approved the operation even though an audit had recommended against it. |22| The sale was officially ratified just a month before the signing of the first bailout package. With Proton bank under his control, Mr. Lavrentadis loaned himself and his associates €600 million with little to no collateral Collateral Transferable assets or a guarantee serving as security against the repayment of a loan, should the borrower default. , channeling €51 million directly into his own accounts. |23| This lending spree was financed with recourse to the Emergency Liquidity Assistance Emergency Liquidity Assistance
Emergency funds loaned to the private banks by the Eurozone central banks.
(ELA) provided by the ECB ECB
European Central Bank
The European Central Bank is a European institution based in Frankfurt, founded in 1998, to which the countries of the Eurozone have transferred their monetary powers. Its official role is to ensure price stability by combating inflation within that Zone. Its three decision-making organs (the Executive Board, the Governing Council and the General Council) are composed of governors of the central banks of the member states and/or recognized specialists. According to its statutes, it is politically ‘independent’ but it is directly influenced by the world of finance.
. |24| Even though it was the responsibility of the Bank of Greece and the HFSF to supervise the operations of Proton Bank they sat idly by while it took the intervention of a special investigation unit of the Greek Supreme Court to expose the fraud. |25| Eventually the HFSF stepped in 2011 to bail out Proton Bank with €1.3 billion of public resources. |26|

The story of corruption at Piraeus bank follows a similar tune. In 2011, Piraeus issued shares to the public as part of the process of strengthening its capital base. Once this process was completed, the family of Michael Sallas, then executive chairman of the bank, emerged as the largest shareholder group of the bank. To accomplish this feat, the Sallas family took out loans totaling €100 million from Marfin Popular Bank (MPB) using the acquired shares as collateral. |27| The auditors of MPB highlighted that the loans were given when the financial prospects of the bank were “deeply negative” and “dire”. |28| It is estimated that nearly one-fifth of the new capital raised by Piraeus was trough loans from other Greek banks. From the perspective of both the Bank of Greece and the HFSF to allow this type of operation represents a major failure in their role of guardians of financial stability. In practical terms, the use of loans from one bank to buy shares in another is nothing short of a Ponzi scheme: as losses materialize in one bank, capital is depleted and shareholders are wiped out, those same losses would extend to the bank providing the loans. This is the reason why, under international rules, banks that engage this type of behavior must both treat the loans as a direct purchase of shares of the other bank and deduct this amount from its own capital base. In the case of the Bank of Greece and the HFSF, they decided to look the other way. |29|

the loans were given when the financial prospects of the bank were “deeply negative” and “dire”

Furthermore, the measures taken by the HFSF led to a dangerous increase in the level of concentration of the financial system of the country. Between 2008 and 2013, Greece registered the largest decrease in credit institutions within the Eurozone. |30| An important part of this process was the almost complete disappearance of foreign subsidiaries and branches that were acquired, with the support and encouragement of European authorities, by two of the largest banks of the country. |31| Greece ended with the most concentrated banking system in the Eurozone: once the first wave of consolidation was completed in 2013, the five biggest credit institutions of the country controlled close to 95% of the total assets of the system. |32| This degree of concentration raises questions regarding the ability of the banks to avoid collusion and protection of vested interests, as well as the capacity of the government to protect itself and the public from the risks associated with the insolvency of said institutions.

By late 2013 it had became evident that the initial attempt to recapitalize Greek banks had all but failed. At that point, the HFSF had effectively allocated €37.3 billion to recapitalize and consolidate the banking system of the country. The remaining funds, of the initial €50 billion allocation, were set up aside as a reserve in case there were further recapitalization needs. As the second programme went off track and speculation for a potential third programme started, the Greek government argued in favor of using the remaining funds available to the HFSF to reduce the overall financing needs of the country. However, as early as September of 2013, officials of the Troika were concerned that the impact of the deterioration of the Greek economy, coupled with the knock on effect of the financial crisis in Cyprus, would entail the use of additional funds to recapitalize the banks beyond the reserves of the HFSF. |33|

The disagreement between Greek authorities and the Troika regarding the true situation of the banks of the country surfaced in early 2014. The BoG leaked to the local press, in advance of a programme review on the subject and without consultation with the Troika, its assessment of the capital needs of Greek banks. In the opinion of the BoG, which assumed a return of banks to profits as early as 2015, capital needs of the banks were expected to amount to €6 billion. In the meantime, both the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
and the ECB considered that figure to be closer to €20 billion. |34| However, for the Troika to press on this issue would have meant two things. First, to push for a deeper restructuring of the banking sector of the country just a year after a massive injection of public funds had taken place. Second, to formally open a discussion on a third rescue package in a situation in which there were no more available funds from the second programme and where they harbored serious doubts regarding the willingness of the Greek government to follow up on its commitments.

Eventually, the both the IMF and ECB took a step back. The IMF, in a review conducted in April of 2014, limited itself to observe that the assumptions used by the BoG were “optimistic” and most likely on the “low end” of the actual requirements. Yet, it refrained from including its own projection of capital needs. As it was, the Fund was projecting that the country was in need of an additional €12.6 billion to cover its funding needs for 2015 without taking into account any additional bank recapitalization funds. |35| This gap had to be covered by either a return to capital markets or through a new programme. To acknowledge the need for additional funds would have closed the first option and made inevitable the second one.

The ECB would follow a similar approach months later. In October of 2014, the ECB conducted a Comprehensive Assessment in order to examine the situation of banks across Europe and determine if additional measures were required to ensure their proper capitalization and operation. As a result of this exercise, the ECB gave a pass in its stress test to three of the 4 main banks of the country. |36| In the case of the fourth, Eurobank, the shortfall was considered to be marginal. |37| This was a very significant turnaround on the position of the ECB given its role as guardian of the financial stability of the country. Furthermore, it indicates that political and strategic considerations trumped financial realities as doubts mounted regarding the capacity of the Greek government to implement the agreement.

political and strategic considerations trumped financial realities

In order to justify their position, the ECB followed a similar approach to that used by the BoG by using projections were based on favorable assumptions. The ECB assumed in its scenarios positive inflation Inflation The cumulated rise of prices as a whole (e.g. a rise in the price of petroleum, eventually leading to a rise in salaries, then to the rise of other prices, etc.). Inflation implies a fall in the value of money since, as time goes by, larger sums are required to purchase particular items. This is the reason why corporate-driven policies seek to keep inflation down. rates ranging from 0.3% to 1.3% between 2014 and 2016. |38| As things were, the country was already experiencing deflation since 2013, with the fall in prices reaching 1.4% in 2014. |39| Given the negative impact of deflation on loan portfolios, the use of realistic assumptions would have led the ECB to recognize a capital shortfall in all of the major banking institutions. By definition, this would have meant acknowledging the failure of the bank recapitalization scheme that was set up in 2012 and the need to trigger a bank resolution process. At this point, the practice of sweeping the problems of Greek banks under the rug had become a routine.

The second process of bank recapitalization (2015 and current situation)

This section provides an overview of the main developments of the banking system in Greece since the beginning of 2015. It discusses in detail the contradictions of the measures adopted by the ECB between its roles as conductor of monetary policy in the Euro zone and enforcer of last resort of the Troika. It then concludes with an overview of the main elements of the second recapitalization scheme for Greek banks and a series of reasons of why it will fall short of its stated objectives.

As the analysis of previous sections makes clear, the Greek banking system was in a precarious state by the time of the elections of January of 2015. On the asset side, the lack of enforcement of changes in management and business model of banks translated into a steady credit contraction and consequent increase of NPL. The uncertain outcome of the negotiations between the Troika and the recently elected Greek government further compounded this problem. On the liability side, banks faced renewed pressures as they were subject to a bank run and forced to increase their reliance on funding provided by the Eurosystem. In this context, systemic bank Systemic bank
Systemic banks
Certain banks are known as systemic because of their size and the danger that would be incurred for the stability of the banking system on a global scale should they fail.
insolvency was not a matter of probability but time. European authorities, and specially the ECB, were aware of this fact and used it in a forceful way to pressure the Greek government. As in previous sections, its worth looking into each of these developments.

systemic bank insolvency was not a matter of probability but time

Credit contraction and the ensuing increase of NPL are the main problems faced by Greek banks on the asset side of their balance sheets. Figures 1 and 2 show these developments. Credit to households and non-financial corporations Non-financial corporations All economic agents that produce non-financial goods and services. They represent the greatest share of productive activity. has fell continuously since the beginning of the crisis. This was a reflection of the economic collapse suffered by the country, and by extension, of the lack of credit demand and bank undercapitalization. Furthermore, NPLs continued the trend established since 2008. It is estimated that by Q2 2015 they were close to €100 billion, effectively clogging the credit system of the country and with it any real chance of economic recovery. |40|

Figure 2 – Greece, domestic credit growth, 2009 – 2015

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Source: Bank of Greece

To compound these problems, a deposit flight was fostered by the lack of a clear commitment from the ECB to provide unlimited supports to banks deemed solvent in its recent stress test. Between December 2014 and July 2015, deposits by domestic private residents went down by €39.4 billion, a reduction equivalent to nearly a quarter of the total deposits (figure 3). |41| Of these outflows, €17.8 billion (45.1% of the total) were transformed into banknotes in circulation. |42| As the funding pressures created by the deposit flight amplified, reliance of Greek banks on the ECB increased. The costs of this dependence increased as a result of the decision by the ECB to withdraw the waiver on eligibility of Greek government bonds as acceptable collateral. Since before the debt restructuring of 2012, Greek government bonds were classified as junk by all the major rating agencies Rating agency
Rating agencies
Rating agencies, or credit-rating agencies, evaluate creditworthiness.  This includes the creditworthiness of corporations, nonprofit organizations and governments, as well as ‘securitized assets’ – which are assets that are bundled together and sold, to investors, as security.  Rating agencies assign a letter grade to each bond, which represents an opinion as to the likelihood that the organization will be able to repay both the principal and interest as they become due.  Ratings are made on a descending scale: AAA is the highest, then AA, A, BBB, BB, B, etc.  A rating of BB or below is considered a ‘junk bond’ because it is likely to default.  Many factors go into the assignment of ratings, including the profitability of the organization and its total indebtedness.  The three largest credit rating agencies are Moody’s, Standard & Poor’s and Fitch Ratings (FT).

Moody’s :
. As a result, they were deemed ineligible as acceptable collateral to access loans from the ECB. However, in order to ensure the proper operation of the Greek financial system, the ECB introduced a waiver to allow banks in the country to use Greek government bonds as collateral to access funding provided by the central bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

. This waiver was cancelled in February of 2015 and was not overturned until the 22nd June 2016. In this context, the ECB steadily increased the provision of ELA to Greek banks, making it conditional to a successful conclusion of the negotiations. Thus, ELA increased from €59.5 billion in February of 2015 to €89 billion at the moment that capital controls were introduced in late June. |43|

Figure 3 – Greece, domestic bank deposits, 2009 – 2016

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Source: Bank of Greece

In this regard it’s important to highlight that the decision of the ECB of limiting the provision of additional liquidity Liquidity The facility with which a financial instrument can be bought or sold without a significant change in price. to the Greek banking system, which effectively brought the imposition of capital controls, contravened the principles of central banking as well as its mandate and core responsibilities. |44| Regarding such principles, one of the main tasks of a central bank is to stem a bank run. To do so, the central bank ought to provide unlimited liquidity against good collateral, so as to ensure that a liquidity issue doesn’t translate into a solvency one. As part of its institutional framework guidelines, the ECB recognizes that this type of liquidity provision its one of its main tools in crisis management: “The institutional framework for financial stability in the EU is based on two components: (i) crisis prevention; and (ii) crisis management and resolution. The ECB, together with the NCBs of the euro area, contributes to both…Authorities can take various steps to manage a crisis and tackle disruption. For instance:… central banks can seek to restore normal liquidity conditions in money markets or take steps to ensure the smooth operation of market infrastructures such as payment systems”. |45| Given that the ECB had deemed Greek banks solvent in the stress tests conducted in 2014, it had the obligation to provide ELA to stem the bank run as long those banks could post collateral in line with its regulations. At the moment the ECB capped the ELA, against the logic of its crisis management tool kit, it is estimated that banks in the country could have accessed up to an additional €28 billion in emergency funding. |46| Therefore is possible to say that with its actions the ECB placed further strains upon the liquidity conditions of the Greek economy as well as caused the disruption of its payments system.

the ECB placed further strains upon the liquidity conditions of the Greek economy

In addition, the actions of the ECB were in breach of two of its explicit responsibilities as set by EU treaties. |47| First, the aforementioned disruption imposed upon the payments system of Greece is in clear violation of ensuring the smooth operation of said system as set for the ECB in Article 127 of the Treaty. Second, the ECB has the mandate to “support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union". |48| One of those economic policies is the “imperative to break the vicious circle between banks and sovereigns”. |49| By forcing the closure of the banks, imposing capital controls and pushing the country close to a de facto and illegal exit from the Euro, the ECB created a situation in which the Greek sovereign and its banks became ever more intertwined. This was done, as was the case in Cyprus in 2013, to force a determined outcome on the ongoing negotiations between the EU and a sovereign nation.

The overall attitude of the ECB in the process of negotiations, violating its mandate and overstepping its authority, was portrayed in the declarations given on June 29th of 2015 by Benoît Coeuré, a member of the ECB executive board. Instead of doing his job as central banker of reassuring markets and depositors alike, Coeuré fueled uncertainty by declaring that “A Greek exit from the euro zone, so far a theoretical issue, can unfortunately not be excluded any more“. |50| In regards to the referendum of July 5th, Coeuré said that if people in Greece were to vote”Yes“for the aid package, he had”no doubt“euro zone authorities will find ways to meet commitments toward Greece. If the”No“vote would have won,”it would be very difficult to resume political dialogue," he said. |51| Suffice to say that such blatant intervention on the internal affairs of a country member is well beyond the purview of a member of the executive board of the ECB.

Despite this long list of problems, the Troika has supported a new round of bank recapitalization in the third Memorandum of Understanding (MoU) following the logic of previous schemes. The latest agreement explicitly limits the ability of the government to implement measures of any kind that may have an impact on bank operations without previous consultation with the members of the Troika. |52| The scheme required an evaluation of the capital needs of the banks in order to conduct their recapitalization before the end of 2015. From a total of €86 billion that were to be lent to Greece as part of the third programme of financial assistance, €25 billion were set aside for bank recapitalization.

The evaluation had to be made on a rush as the process of recapitalization had to be completed before the full implementation of the EU Bank Recovery and Resolution Directive (BRRD) that was set to come into effect on January 1st of 2016. The BRRD required to bail in 8% of bank liabilities Liabilities The part of the balance-sheet that comprises the resources available to a company (equity provided by the partners, provisions for risks and charges, debts). before the disbursement of resources by the European Stability Mechanism ESM
European Stability Mechanism
The European Stability Mechanism is a European entity for managing the financial crisis in the Eurozone. In 2012, it replaced the European Financial Stability Facility and the European Financial Stabilisation Mechanism, which had been implemented in response to the public-debt crisis in the Eurozone. It concerns only EU member States that are part of the Eurozone. If there is a threat to the stability of the Eurozone, this European financial institution is supposed to grant financial ‘assistance’ (loans) to a country or countries in difficulty. There are strict conditions to this assistance.
(ESM). In practical terms this would have meant, besides wiping out unsecured creditors, a partial haircut on unsecured deposits over €100.000. |53| Even though the use of a bail in mechanism would have been an adequate solution at the beginning of the crisis, as it would have allowed for a more equitable distribution of the losses, currently it could do more harm than good, especially in the case of the depositors. Given the characteristics of the ESM recapitalization tool, between 13 to 39% of unsecured depositors would have been subject to a haircut. As most of the large depositors have already transferred their money abroad, the haircuts would have disproportionally affected the working capital of Greek businesses. |54| These figures highlight how the decision to delay the recognition of losses and insolvency of Greek banks continues to shift the costs of the crisis on to the public balance sheet.

In the event, the ECB concluded its assessment of the financial system of the country at the end of October of 2015. The exercise identified a capital shortfall in Greek banks of €4.4 billion in the baseline scenario and €14.4 billion in an adverse scenario. |55| In this regard, one of the most interesting aspects about this assessment was the use of significantly higher capital requirements for Greek banks when compared to the previous review conducted less than 12 months before. |56| This conservative approach also extends to the use of macroeconomic assumptions. As has been explained, previous assessments were characterized by the use of rosy projections. In contrast, the latest stress test included in its adverse scenario a prolonged recession and sustained deflation for the 2015-2017 period. |57| Under the light of the events that transpired in 2015, one has to be forced to question the reasons why the ECB didn’t apply the same conservative approach at the end of 2014. Given the thin margins with which Greek banks passed that test, it’s clear that the use of more conservative assumptions would have triggered a wide scale resolution process of those banks as early as 2013, when the doubts by the IMF and ECB regarding the first process of bank recapitalization had surfaced. Questionably enough, the ECB fails to provide in its latest assessment any explanation for the change in its approach. |58|

Nonetheless, the results of the assessment were greeted with optimism from European officials as the maximum capital shortfall identified by the ECB of €14 billion was well bellow the amount of €25 billion allocated for the purpose of bank recapitalization in the third MoU. |59| Furthermore, based on these results, Greek banks had a week to present to the ECB their recapitalization plans and over a month to execute them before the BRDD came into effect. By December, banks were able to obtain €8.3 billion from private sources through the use bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. swaps, book building and bail in tools. The remaining €5.4 billion were provided by the HFSF with bailout funds. |60|

It’s important to highlight that the second process of recapitalization led to a dramatic change in the structure of bank shareholders. The new shares that were issued had a discount on the last quoted price ranging from 34.4% in the case Alpha, to 80 and 93% in the cases of Piraeus and NBG. |61| As a result the participation of the HFSF in the banks capital, bought with more than €40 billion of bailout funds, was heavily diluted: it went from 66.2% to 11% in the case of Alpha; from 35.4% to 2.3% in the case of Eurobank; from 57.4% to 40.3% in the case of NBG and from 66.9% to 26.4% in the case of Piraeus. |62| This extreme dilution of the public participation in local banks stands in contrast to the approach taken in 2012 to protect private shareholders. In the context of the third MoU, the measure was justified as a way to reduce the use of bailout funds for bank recapitalization through the participation of private funds. In this regard, given the need to protect unsecured depositors, mainly the working capital of SMEs, additional recapitalization funds without dilution would have meant complete control by the HFSF of the banking system of the country. In order to avoid this outcome, which is an anathema to the ECB, the only possible option was to effectively write down the shares in possession of the HFSF and sell them for a fraction of their price to private investors. Furthermore, even though these shares came with strict restrictions regarding the degree of control and influence the Greek government could exert over the bailed out banks, their dilution still represents a material patrimonial loss to the Greek public sector. After all, their sale was expected to be a central part of the €50 billion privatization fund that was established as part of the third MoU. |63|

Furthermore, as a complement to the injection of additional public funds into the banks, the MoU included extensive measures aimed at tackling the NPL problem. However, these mainly rely on institutional and legal procedures to accelerate the process of liquidation of loans and establishment of a secondary market Secondary market The market where institutional investors resell and purchase financial assets. Thus the secondary market is the market where already existing financial assets are traded. for NPLs. |64| In this regard, the proposed measures allow each bank to manage its own portfolio of NPLs. This is problematic on at least two grounds. First, as banks will be able to access new funding this may reduce the incentives to undertake the necessary operational restructuring. For example in the case of Japan, as banks were able to carry non performing loans at low costs this translated into little inclination from their part to undertake corporate restructuring. |65| In the case of Greece, with it’s long and documented history of cronyism, it would simply allow for the same patron-clientele relationships to continue unabated as the banks could choose which loans to keep. Second, the establishment of a centralized asset management company would provide it with economies of scale, in terms of management, operative capacity and low cost funding, which would increase the recovery rates of NPLs.

In this regard, it’s clear that the fate of banks and the resolution of the NPL problems are closely intertwined with the recovery of the economy. Unfortunately, given the negative impact of the additional fiscal consolidation that the country is expected to achieve over the next 3 years, the recovery of the economy would be too slow to gather momentum or to make a dent on unemployment. |66| Thus, it’s unlikely that the new round of recapitalization will be enough on its own to restore the stability of the Greek banking system without the inclusion of additional measures to deal with NPLs in a coordinated way, alongside with dramatic changes in bank management. The IMF has recently recognized as much. Despite the optimism of European officials regarding the outcome of the last recapitalization scheme, the DC based organization estimates that Greek banks will require at least an additional €10 billion to cover capital needs. |67| The IMF also emphasizes that without significant changes to the governance of Greek banks, as well as measures to strengthen their balance sheets, the problems observed in recent years will continue into the future. |68|

This assessment, made less than a year into the second bank recapitalization by one of the members of the Troika, encapsulates the problems with the official policy response to the crisis. Seven years into it, its still unclear how much additional resources will be required to stabilize the financial system of the country. Furthermore, those responsible for many of the excesses that took place before 2008 remain in charge of the banks while the costs of the crisis keep being shifted onto Greek taxpayers. In this regard, and given the complex situation in which Greek banks find themselves today as a result of the policies implemented by the Troika, the proposition of an alternative plan to restore them to stability falls beyond this report. However, its clear that such a plan is required as the policies currently in place have already proven a resounding failure with no end in sight.


|1| IMF. (2013). Greece: Ex Post Evaluation of Exceptional Access under the 2010 Stand-By Arrangement, IMF Country Report No. 13/156. Retrieved June 12, 2015, from

|2| Xafa, M. (2014). Sovereign Debt Crisis Management: Lessons from the 2012 Greek Debt Restructuring. Retrieved May 20, 2016, from

|3| There were an additional €28 billion bonds under English law, which could not be subject to this treatment. From this group, holders of €6.4 billion became holdouts of the debt restructuring, receiving payment in full of their claims.

|4| Zettelmeyer, J., Trebesch, C., & Gulati, M. (2012). The Greek Debt Exchange: An Autopsy. Retrieved from

|5| Ibid.

|6| Bank of Greece. (2012). Report on the recapitalisation and restructuring of the Greek banking sector. Retrieved from

|7| Zettelmeyer, J., Trebesch, C., & Gulati, M. (2012). The Greek Debt Exchange: An Autopsy. Retrieved from

|8| IMF. (2012). Greece: Request for Extended Arrangement Under the Extended Fund Facility, IMF Country Report No. 12/57. Retrieved September 21, 2015, from

|9| Bank of Greece. (2012). Report on the recapitalisation and restructuring of the Greek banking sector. Retrieved from

|10| In May of 2012, the IMF projected real GDP growth of -4.8% for 2012, 0% in 2013 and 2.5% in 2014, the actual growth for those was -7%, -3.9% and 0.8% respectively. IMF. (2012). Greece: Request for Extended Arrangement Under the Extended Fund Facility, IMF Country Report No. 12/57. Retrieved September 21, 2015, from; IMF. (2014). GREECE FIFTH REVIEW UNDER THE EXTENDED ARRANGEMENT UNDER THE EXTENDED FUND FACILITY, IMF Country Report No. 14/151. IMF Country Report No. 14/151. Retrieved October 16, 2014, from

|11| IMF. (2014). GREECE FIFTH REVIEW UNDER THE EXTENDED ARRANGEMENT UNDER THE EXTENDED FUND FACILITY, IMF Country Report No. 14/151. IMF Country Report No. 14/151. Retrieved October 16, 2014, from

|12| Ibid.

|13| HFSF. (2016). Hellenic Financial Stability Fund - What we do. Retrieved May 21, 2016, from

|14| HFSF. (2012). HFSF Annual Report 2010-2011. Retrieved May 21, 2016, from

|15| As of June of 2015, the HFSF retained 57.2% of the shares of NBG, 35.4% of Eurobank, 66.2% of Alpha and 66.9% of Piraeus with an estimated market value of €7.5 billion. As will be discussed later on in this text, these participations were diluted as a result of the bank recapitalizacion process that took place in November of 2015. Data provided to the Debt Truth Committee by the Bank of Greece.

|16| IMF. (2012). Greece: Request for Extended Arrangement Under the Extended Fund Facility, IMF Country Report No. 12/57. Retrieved September 21, 2015, from

|17| Mayes, D. (2009). Banking crisis resolution policy - different country experiences. Central Bank of Norway. Retrieved from

|18| Reuters. (2012). Greek banking governance is a gamble. Retrieved May 21, 2016, from

|19| Reuters. (2015). Greek bank bailout fund CEO asked to resign -government official. Retrieved February 1, 2016, from

|20| ThePressProject. (2014). Head of Greek bank rescue fund to face charges over crony loans in Hellenic Postbank scandal - UPDATE. Retrieved February 1, 2016, from

|21| Ibid.

|22| ThePressProject. (2014). George Provopoulos: The most powerful man in Greece a few months ago, now a suspect in a bank probe. Retrieved February 1, 2016, from

|23| Reuters. (2012). Special report: Greece claims magnate stole from his own bank. Retrieved February 1, 2016, from

|24| Ibid. The ELA refers to funding provided, in this case by the Bank of Greece, to a solvent financial institution, or group of solvent financial institutions that is facing temporary liquidity restrictions. Bank of Greece. (2014). The Chronicle of the Great Crisis, The Bank of Greece 2008 - 2013. Retrieved from Chronicle Of The Great Crisis.pdf

|25| Ibid.

|26| Reuters. (2011). Greece activates rescue fund to save Proton Bank. Retrieved February 1, 2016, from

|27| Reuters. (2012). Special Report: Clandestine loans were used to fortify Greek bank. Retrieved February 1, 2016, from

|28| Ibid.

|29| Ibid.

|30| ECB. (2014). Banking Structures Report 2014. Retrieved January 29, 2016, from

|31| Ibid.

|32| Ibid.

|33| Financial Times. (2013, September 16). Third time lucky? The latest plan to rescue Greece. Retrieved from

|34| Financial Times. (2014, February 14). Greece in banking sector stand-off with bailout lenders — Retrieved from

|35| IMF. (2014). GREECE FIFTH REVIEW UNDER THE EXTENDED ARRANGEMENT UNDER THE EXTENDED FUND FACILITY, IMF Country Report No. 14/151. IMF Country Report No. 14/151. Retrieved October 16, 2014, from

|36| ECB. (2014). Aggregate Report on the Comprehensive Assessment. Retrieved from

|37| Ibid.

|38| Ibid.

|39| European Commission. (2015). European Economic Forecast Spring 2015. Retrieved from

|40| Ekathimerini. (2015). Banks fear NPL sum will reach 100 bln euros. Retrieved from

|41| Bank of Greece. (2015). Deposits Statistics. Retrieved from

|42| Bank of Greece. (2015). Financial Statements. Retrieved from

|43| Barclays Research. (2015). Greece: Capital controls imminent without breakthrough.

|44| Wyplosz, C. (2015). Grexit: The staggering cost of central bank dependence. Retrieved September from

|45| ECB. (2015). Macroprudential policy and financial stability. Retrieved from ; Klein, M. (2015). Greece shows ECB’s stress tests were nonsense. Financial Times. Retrieved from

|46| Barclays Research. (2015). Greece’s Achilles heel.

|47| Sandbu, M. (2015). ECB, enemy of the euro? Financial Times. Retrieved from

|48| European Commission. (2012). Consolidated version of the Treaty on European Union, 2012/C 326/01. Retrieved from

|49| Council of the European Union. (2012). Euro Area Summit Statement 29 June 2012. Retrieved from

|50| Reuters. (2015). ECB’s Coeure says Grexit now a possibility. Retrieved January 27, 2016, from

|51| Ibid.

|52| European Commission. (2015). Greece Memorandum of Understanding for a three-year ESM programme. Retrieved from

|53| Merler, S. (2015). Preserving the Greek financial sector: options for recap and assistance. Bruegel. Retrieved September 22, 2015, from

|54| Coppola, F. (2015). The coming Greek bank nationalization, bail-in and privatization - Credit Writedowns. Retrieved from

|55| ECB. (2015). AGGREGATE REPORT ON THE GREEK COMPREHENSIVE ASSESMENT. Retrieved February 2, 2016, from https://www.bankingsupervision.euro...

|56| Whereas in 2014 the ECB required banks to achieve a CET1 ratio of 8% in the baseline scenario and 5.5% in the adverse scenario, in the new assessment it required a CET1 ratio of 9.5% and 8%, respectively. Ibid.

|57| Ibid.

|58| Merler, S. (2015). Greek bank recap. Bruegel. Retrieved February 2, 2016, from

|59| Zero Hedge. (2015). Greek Bad Debt Rises Above 50% For The First Time, ECB Admits. Retrieved February 2, 2016, from

|60| Macropolis. (2015). Greek banks complete book building: A recap of where we stand. Retrieved from

|61| Ibid.

|62| Macropolis. (2016). Last round of Greek banks’ recapitalisation drastically shifts shareholder structures. Retrieved from

|63| WSJ. (2015). How Will The Greek Privatization Fund Work? Retrieved February 2, 2016, from

|64| A more detailed explanation of the measures taken regarding NPLs can be found on a previous draft of this text. Munevar, D. (2016). An analysis of the recapitalization of Greek banks in the context of the third Memorandum of Understanding. Retrieved June 12, 2016, from

|65| Claessens, S. (2000). Experiences of resolution of banking crises. BIS. Retrieved from

|66| Papadimitriou, D., Nikiforos, M., & Zezza, G. (2016). HOW LONG BEFORE GROWTH AND EMPLOYMENT ARE RESTORED IN GREECE? Levy Economics Institute of Bard College Strategic Analysis. Retrieved February 3, 2016, from

|67| IMF. (2016). Greece: Preliminary Debt Sustainability Analysis—Updated Estimates and Further Considerations - IMF Country Report No. 16/130. Retrieved from

|68| Ibid.


Daniel Munevar

is a 30-year-old post-Keynesian economist from Bogotá, Colombia. MPAff. LBJ School of Public Affairs at the University of Texas at Austin. From March to July 2015 he worked as a close aide to former Greek finance minister Yanis Varoufakis, advising him on issues of fiscal policy and debt sustainability. He was previously fiscal advisor to the Ministry of Finance of Colombia and special advisor on Foreign Direct Investment for the Ministry of Foreign Affairs of Ecuador. He is considered to be one of the foremost figures in the study of Latin American public debt. He is member of CADTM AYNA.




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