TherecapitalizationofGreekbanks

PeterDalianesandDimitriVayanos1 3December2011 Abstract

BecauseoftheimpendinghaircutonGreekgovernmentbonds,andofthelargefractionofnon performingloans,Greekbanksarelikelytobeinsolventonaggregate.Callsforincreasedstate ownershipofthebankingsystemasalongrunsolutiontotheproblemshouldberesisted:state controldistortslendingdecisionsofbanksandhinderstheireffectiveregulation.DataonGreek banks'holdingsofGreekgovernmentbondsconfirmthecostsofstateinfluence.Recapitalization shouldproceedpromptlyasfollows.SolventbanksshouldberequiredtomeettheirBaselcapital ratios,andinawaythatinvolvesnotonlyassetsalesbutalsoinjectionsoffreshcapital.Banksthat areinsolventbutnotdeeplysoshouldcontinueoperations,existingequityshouldbesettozero, andcapitalratiosshouldberestoredthroughinjectionsofcapital.Ineithercase,existingequity holdersshouldbegiventhechancetoprovidethenecessarycapitalbeforepublicfundsareinjected. Theprocessshouldbemonitoredcarefullybythetroikatoensuregoodcorporategovernanceinthe banksthatreceivepublicfunds.Banksthataredeeplyinsolventshouldbeliquidatedthroughagood bank/badbankscheme.

PeterDalianesisanAssetManagementConsultant.DimitriVayanosisaProfessorofFinanceattheLondon SchoolofEconomics.
1

Introduction
OneofthemainreasonswhytherecessioninGreeceissodeepisthedifficultythatfirmshaveto borrowfrombanks.Greekbanksareextremelyconstrainedintheirlendingbecauseofthelosses thattheyhaverealizedorareexpectingtorealizeintheirassetportfolios.Thelossesstemfrom banksholdingsofGreekgovernmentbonds,aswellasfrombanksnonperformingloans(NPLs)to theprivatesector.2 AccordingtotheBankofGreece,theaggregatecapitalofGreekbankswas47billionEurosin September2011.Moreover,Greekbanksheld58billionofclaims(bondsandotherloans)onthe Greekgovernment,andtheirloanstotheGreeknongovernmentsectorwere251billion.Assuming ahaircutof50%ofgovernmentdebt,thelossesonclaimstotheGreekgovernmentwouldbe29 billionEuros.ProvisionsforNPLswere18billioninSeptember.AssumingthatactualNPLlossesturn outtobeequaltoNPLprovisions,Greekbankshaveexactlyzerocapitalonaggregate,basedon thesenumbers(472918=0).Moreover,thesenumbersarelikelytounderstatetheextentofthe losses.Indeed,thehaircutongovernmentdebtislikelytoexceed50%,andNPLlossesarelikelyto exceedtheprovisions.Assumingahaircutof60%,forexample,andNPLlossesof25billion,Greek banksareinsolventonaggregateby13billion. RestoringtheGreekbankingsystembacktofinancialhealthiscrucialforthegoodfunctioningofthe Greekeconomyandforexitingthecurrentcrisis.Buthowshouldthisbedone?

ThePerilsofStateControl
Somepoliticiansandcommentatorsarguethatanessentialelementofthesolutionisgreaterstate controlofbanks,e.g.,intheformofstateownershipofsomekeybanks.Afewgoevenfurtherand argueforanationalizationoftheentirebankingsystem.Movesinthisdirectionwouldbedisastrous andsettheGreekeconomymanyyearsback.Indeed,statecontrolofbanksisharmfulbecauseit opensthedoortopoliticalinfluenceandcorruption.Forexample,statecontrolledbankscanbe coercedtochannelcredittopoliticallyconnectedfirmsandtothegovernment,evenwhensuch loanshavelittleeconomicmerit.Moreover,managersofstatecontrolledbankscanbechosen basedontheirpoliticalconnectionsratherthantheirbankingskills,andpoliticianscanpreventbank regulatorsfrommonitoringeffectivelystatecontrolledbanks.Forallthosereasons,statecontrolof banksisharmful,andthishasbeenconfirmedbyanumberofacademicstudies.Forexample,La Portaetal.(2002)findthatgreaterstateownershipofbankspredictslowgrowthofGDPandof productivityacrossacrosssectionofcountries. Ofcourse,thestatehasanimportantroletoplayinsafeguardingthegoodfunctioningofthe bankingsystem:banksmustbesupervisedsothattheydonottakeexcessiveriskswithdepositors money.Thisrole,however,shouldbeperformedbyanindependentregulatoryauthority,whichin thecaseofGreeceisthatBankofGreece.Regulatoryauthoritiesshouldbewellstaffed, accountable,andindependentfrompoliticiansandbanks.Theeffectivesupervisionofbankscannot beaccomplishedbystateownershipofbanks.Stateownershiphas,infact,theexactopposite
2

Nonperformingloansareloansforwhichtheborrowerhasmissedsomepayments.

effect:ithinderseffectivesupervisionbecausepoliticalpressurespreventregulatorsfrom monitoringvigorouslystatecontrolledbanks. ThecontrolofbanksbythestatehasbeendeclininginGreece.Yet,thestatesinfluenceisstill present,anditscostsarevisible.Consider,forexample,banksholdingsofGreekgovernmentbonds (GGB).Table1showsthefivelargestGreekbanksintermsof2010assets:NationalBankofGreece (NBG),EFGEurobank,AlphaBank,PiraeusBank,andAgriculturalBankofGreece(ABG).State influenceislargestforABGandNBG.(NBGhasbeenprivatized,butthestateretainscontrolthrough minorityholdingsofstatepensionfunds,ascanbeseen,forexample,bythefactthattop managementchangedaftereachofthe2004and2009nationalelections.)Onewould,therefore, expectthatABGandNBGcanbepressuredmoreeasilybythegovernmenttobuyGGB,andhold largeramountsofGGBintheirportfolios.ThisisconfirmedinTable1:ABGranksfirstintermsof GGBholdingsasapercentageofassets,whileNBGranksthirdandonlyslightlybelowPiraeusBank. LargeholdingsofGGBharmedthebanksbecausetheyprecludedtheireffectivediversification acrosstheEurozone,andleftthemoverexposedtotheriskofdefaultbytheGreekgovernment. Table1:AssetsandholdingsofGreekgovernmentbonds(GGB)ofthefivelargestGreekbanks. (NumbersareinbillionsofEuros.Assetsarefromannualreports.HoldingsofGGBsarecalculated fromannualreportsandinterimstatements.) NationalBank ofGreece 121 13.5 11.2 EFGEurobank AlphaBank PiraeusBank Agricultural Bankof Greece 31 5.7 18.4

Assets Holdingsof GGB Holdingsof GGBas%of assets

87 7.5 8.6

70 3.0 4.3

58 6.9 11.9

Whilestatecontrolofbanksisharmfulingeneral,somestateinvolvementintheGreekbanking systemisunavoidableinthecurrentcrisis.Indeed,Greekbanksmustraisenewcapital.Perhaps somebankswillbeabletoraiseprivatecapital,butmanywillnot,andthiscapitalwillhavetocome fromtheGreekstateasaloanfromthetroika.TheGreekstatewillhenceneedtohaveasayonthe managementofthebanks,inexchangeofprovidingthefunds.Theprocess,however,mustbe structuredcarefullytoavoidtheperilsofpoliticalinterference.

EfficientRecapitalization
Anefficientrecapitalizationprogramshouldhavedifferentprescriptionsfordifferentbanks, dependingontheirsolvency.Assessingsolvencyrequiresmeasuringassetsandliabilities,aprocess whichisdifficult,especiallyinthecaseofassets.Itisessentialtohavearelativelyprecise assessment(currentlyperformedbyBlackrock),andtoactuponitpromptly.Wedistinguishthree cases.

1. Solventbanks:Banksforwhichassetsexceedliabilitiesshouldberequiredtomeettheir Baselcapitalratios,i.e.,theirequitycapitalshouldbeatleast8.5%ofassets.Moreover,this targetshouldbemetmainlybyraisingfreshcapitalandnotbyassetsales. Assetsalesbyonebankcreateanegativeexternalityforotherbanksandfirms:theyreduce assetvalues,andhencereducebanksabilitytolend,deepeningtherecession.Policymakers shouldtaketheexternalityintoaccountandmandateaminimumlevelofcapitalthatbanks shouldraiseinabsolutetermsandnotaspercentageofassets. IfbanksfailtomeettheirBaselcapitalratiosandtoraisetheminimumlevelofequitycapital fromprivatesources,thentwooptionsshouldbeconsidered.Oneisadebt/equityswap, wherethebondholdersofabankconverttheirdebtintoequity.AsecondisthattheGreek stateacquiresequityinthebank.Thetwooptionsarecloselyrelated:sincemuchofthe debtofGreekbankscarriesguaranteesbytheGreekstate,theGreekstatewouldbebearing thelossesandhenceshouldbeacquiringtheequity. Theprovisionofcapitalfromprivateandpublicsourcesshouldbenegotiatedina coordinatedmannerforeachbank,andallcapitalprovidersshouldreceiveequaltreatment. Forexample,ifprivatecapitalis60%ofthenewcapitalandpubliccapitaltheremaining 40%,then60%ofthenewsharesshouldbegiventotheprovidersofprivatecapital.The newsharesshouldbeissuedatadiscountrelativetothepriceatwhichthebanksstockis traded,hencedilutingexistingequityholders.Dilutionisnecessarybecauseofthedebt overhangproblem:theprovidersofnewcapitalmustbecompensatedforthefactthatsome oftheircapitalislikelytogotobondholders. ArecapitalizationplaninwhichtheGreekstateacquiresequitywillsucceedonlyifpolitical interferenceisminimal.Thestatesrecordinthatrespectispoor.Thestatesparticipationis currentlythroughtheHellenicFinancialStabilityFund(HFSF).TheHFSFshouldbewell staffedandbegivenappropriatepowers,independenceandaccountability.Itisimportant, however,thattheprocessismonitoredcarefullybythetroika,boththroughitsappointees attheHFSFandthroughboardmembersthatthetroikashouldappointatthebankswhere publicfundswillbeinjected.Thiswillhelpensuregoodcorporategovernanceduringthe transitionstageuntilabankissoldagaintotheprivatesector.Itisessentialthatthe financialassistancethatGreeceisreceivingisusedtoimprovecorporategovernance,and notasavehicletoreturntobadpracticesofthepast. 2. Banksthatareinsolventbutnotdeeplyso:Banksforwhichassetsarelowerthanliabilities butnotbymuchshouldtypicallybeallowedtocontinuetheiroperations.Theexistingequity shouldbesettozero,andBaselcapitalratiosshouldberestoredthroughinjectionsoffresh capitalandpossiblydebtequityswaps.Asinthecaseofsolventbanks,existingequity holdersshouldbegiventhechancetoprovidethenecessarycapital,andifnotenough privatecapitalbecomesavailable,publicfundsshouldmakefortherest. ArecapitalizationplanalongtheselineswasperformedsuccessullyintheUKinthecontext ofthe2008crisis.TheUKstateacquiredequitystakesinRoyalBankofScotlandandLloyds,

andchangedthetopmanagementinthosebanks.Ithasalreadysoldsomeofitsequity stake. Asinthecaseofsolventbanks,thetroikashouldexercisecarefulmonitoringthroughits appointeesattheHFSFandatbanksboards.Thetopmanagementofabankshouldbe changedinanumberofcases.Thebankshouldberestoredtohealthandthestateshould sellitsequitystaketoprivateinvestorsinafewyears.Itwouldbedesirablethatsomeofthe equityispurchasedbylongtermstrategicinvestors,includingotherEurozonebanks. Indeed,asCalomirisetal.(2004)pointout,entrybyforeignbankscarriesmanyadvantages: (a)newcapitalisinjectedinthebankingsystem,(b)competitivepressureondomesticbanks isincreased,and(c)bankregulationisimprovedandenforcedmorestrictly. 3. Deeplyinsolventbanks:Banksforwhichtheirassetsaremuchlowerthanliabilitiesshould becloseddown.Thestateshouldcompensatethedepositorsandsellorsettletheloansto recoversomeofthecompensationproceeds.Theexistingequityshouldbesettozero.The rationaleofliquidatingdeeplyinsolventbanksisthattheinsolvencyislikelytoreflectthe poorqualityofthebanksmanagementandtoalsosignalpoorfutureinvestment opportunities. Theliquidationcanbedonethroughagoodbank/badbankscheme,aswasdoneinSweden inthe1990s(Calomirisetal.2004).Thegoodbankkeepsthedeposits,whicharecoveredby agovernmentguarantee,andpossiblysomegoodloans.Thebadbankkeepstheremaining assets,andconvertsthemgraduallyintocash.TheGreekstatehasfollowedthisroute recentlyinthecaseofProtonBank. Thegoodbank/badbanksolutionwassuccessfulinSwedeninthatthebadbanksassets wereliquidatedpromptlyandefficiently.ButasCalomirisetal.(2004)pointout,efficient liquidationrequiresanefficientjusticesystemandastrongregulatorthatcanwithstand politicalpressures.IncomparablesituationsinMexicoandIndonesia,theliquidationof assetswasslowandinefficient.GiventheinstitutionalweaknessesinGreece,thegood bank/badbanksolutionislikelytobeproblematicespeciallyifusedatalargescale.Atthe veryleast,thebadbankshouldbewellstaffedandbegivenappropriatepowers, independenceandaccountability.

References
Calomiris,C.,D.KlingebielandL.Laeven(2005),FinancialCrisisPoliciesandResolution Mechanisms:ATaxonomyfromCrossCountryExperience,inP.HonohanandL.Laeven(Eds.), SystemicFinancialDistress:ContainmentandResolution,Cambridge. LaPorta,F.,R.LopezdeSilanesandA.Shleifer,(2002),GovernmentOwnershipofBanks,Journalof Finance,57,265301.