The Greek government
seems to have reached a decision as to the fate of creating a “Bad Bank” to
resolve the problem of bad loans appearing on the balance sheets of the four
systemic Greek banks.
The banking system may
undergo once again an overhaul by further shrinking with an apparent merger.
Thus far, the government does not want to accept to proposal of the central
bank of Greece to create a bad bank. They believed that the Hercules plan to
handle the problem of non-performing loans is sufficient by securitizing bad
loans.
To explain securitization
banks are required to hold capital requirements, a certain portion of own
equity for each different type of asset on their balance sheet so as to prevent
them from high leverage. Financial regulators (SSM) have introduced complex
capital requirement rules, which determine the minimum amount of equity a bank
needs to have on its balance sheet. If a bank is well capitalized (meaning has
sufficient equity) it be able to withstand adverse market conditions.
Based on the Basel rules,
banks need to maintain a capital ratio based on the risk profile of the assets
on their balance sheets. This means that different types of assets are weighted
differently and thus more capital needs to be held for riskier assets. An
example as to how types of assets can be ordered in terms of risk weight are:
reserves 0%, treasury securities 0%, home mortgages 50%, commercial loans 100%.
The question arises as to
why do banks need securitization, as the Greek banks have already began doing
for the bad loans on their balance sheets. Capital is expensive and by
definition, a more capitalized a bank is, the lower the return on equity (ROE)
will be. Since all banks want to have a high ROE they have to work with risky
assets. Regulations impede banks from holding more than a certain amount of
risky assets without additional capitalization, which lowers profitability (we
will see below that in the case of Greek banks it will expose losses).
The solution they came up
with is securitization where Greek banks “package” a group of assets (in this
case the bad loans) on their balance sheets and sold to investors. Greek banks
have already done this and have created a special purpose vehicle where they
will transfer these packaged loans to, and sell them to investors (many have
already found investors (mutual funds). The special purpose vehicle (SPV) is a
new company where the banks transfer the mortgage loans.
Once investors buy the securitized assets the bank frees up its balance sheet and can invest in new securities, and banks profit from origination and commissions of the loans in the SPV. On the other hand, investors would buy these securities because they would have a return on investment compared to bond securities with similar credit ratings, and diversification benefits since some investors do not have a direct access to mortgage loans.
Strong supporters of the
Hercules plan are the union of Hellenic banks and the heads of the four
systemic banks, but those that monitor the Greek economy (IMF, EU commission)
in their last reports, conclude on the same findings, which is that the
Hercules plan is not enough for the consolidation of the Greek banking system
and their portfolios.
Their capital is of poor
quality giving the fact that there is the issue of the deferred tax credit (DTC,
see previous article), which is composed of 60% of their total assets. The
creating of the bad bank has also opponents among cabinet members since it will
bring a shake up to the existing equilibrium in the banking system which has
prevailed for years, and brought the annihilation and consolidation with a
total market share of 90%.
The plan of the central
bank and its governor is to create a band bank, and transfer the non-performing
loans (NPL) worth more than €40 billion. This will clean up the banks’ balance
sheets. The view in the European Union is that the current banking system in
Greece is at a stalemate, and is unable to handle NPL’s. That is why they are
determined and have giving their ok to go forward with the plan even though
that may mean a further shrinkage in the number of banks by a merger, thus sacrificing
a sacred cow.
The transfer of the NPL’s
to the band bank will unveil the hidden losses on the balance sheets so as not
to be considered state aid (from the DTC), with a valuation close to market
value, lower than the valuation reported on the banks’ balance sheets. This
will have a negative effect on their assets.
To alleviate this, the
central bank of Greece proposes the provision of losses be treated in more than
one fiscal year. The need of capital will be exposed and will be presented to
the SSM in order to cover those needs. From this process the conclusion is that
one of the systemic banks will be absorbed by the other three. The new European
statute provision states that Capital enhancement is prohibited without a
haircut to creditors and depositors, so to avoid this, the only solution is a
merger.
Bill T. Alexandratos
October 2020
