Greece working on how to save its banks

A Bloomberg article described the on-going efforts by Greece to use its scarce financial resources to 'save' its banks with a bailout.

Regular readers know that using government resources to 'save' the banks in a modern banking system via a bailout is unnecessary.  By design, these banks can operate with negative book capital levels.  As a result, these banks have access to unlimited funding through retention of future earnings that can be used to rebuild their book capital level.

As Greeks prepare for an election that’s unlikely to produce a clear winner, interim Prime Minister Lucas Papademos is struggling to complete his final major task: stopping banks from falling into state hands.

The government approved a law last week setting the framework for the Hellenic Financial Stability Fund, the state’s recapitalization fund. It included the authorization to give banks capital upfront and a possible plan to enable them to book smaller losses on the bonds issued in last month’s debt swap. 

“The state will do what they can to keep the banks operating as living entities and avoid nationalizations where possible,” said Alex Tsirigotis, an analyst at Mediobanca SpA (MB) in London. “Functioning banks will be important to support any domestic economic revival.”...

Keeping the banks functioning and operating as living entities requires that three conditions are satisfied.

First, that the banks' deposits are implicitly or explicitly guaranteed in a credible manner.  With the Greek sovereign teetering on the brink of bankruptcy, it is not a credible guarantor.  It needs to be backstopped by the European Financial Stability Fund (EFSF) and the European Stability Mechanism (ESM).

Second, that ECB continues to be willing to lend against good collateral.  This prevents any risk of a bank collapsing because of a run on its funding.

Third, that the banks provide ultra transparency and disclose on an on-going basis their current asset, liability and off balance sheet exposure details.  With this information, market participants can independently assess the risk of the banks and exert discipline to prevent the banks from increasing their risk profile in order to gamble on redemption.

“Many issues can’t wait until after the elections to be addressed,” Papademos told his cabinet on April 11 when he announced the date of the vote. “We have to specify the conditions for the bank recapitalization, which is essential for enhancing the economy’s liquidity.” 

The IMF, which is helping finance Greece’s second rescue package, estimates the debt restructuring will mean impairments of about 22 billion euros for the country’s banks. That compares with the industry’s tier 1 capital, a key measure of a bank’s strength, of 23.8 billion euros as of September. In addition, banks had non-performing loans equal to 14.7 percent of total lending at the end of September, the IMF said. 

“Bank solvency has become an acute problem” in Greece, the IMF said in a report released March 16. “Regulatory capital will be wiped out for four banks representing 44 percent of system assets, while the remaining banks would end up significantly undercapitalized.”

Actually, bank solvency is not an acute problem.  Bank solvency varies over time.  A bank can be insolvent (the book value of its liabilities exceeds the market value of its assets) and continue to operate.

It is bank funding liquidity that is a potentially acute problem.  A lack of access to funds is what ends bank operation, not a lack of capital.

The presence of the three conditions discussed above (deposit guarantee, central bank liquidity, ultra disclosure) keeps the liquidity problem from becoming acute.

The IMF, EU and European Central Bank, the troika of agencies overseeing the Greek financing, plan to help capitalize banks with incentives for private investors. The goal is to bring core tier 1 capital to 9 percent of assets by the end of September....

Inspectors from the so-called troika have to sign off on the recapitalization plans before they can be implemented. 

Greece is due to receive a 25 billion-euro first tranche of funds from the European Financial Stability Facility for the recapitalization, half of the total public funds earmarked.... 

The plan includes incentives for private investment in the banks such as rights for shareholders to purchase the government’s stake and safeguards for buyers of convertible bonds, according to the IMF report. 

The Greek stability fund will continue to have voting rights in the event of strategic decisions related to the banks to avert the risk of asset stripping by investment funds, it said. 

Outstanding issues include the price at which the state and private investors will buy the shares and the mix of equity and contingent convertible bonds, known as CoCos, according to a note this week from HSBC Pantelakis Securities SA. 

Failure to persuade private investors to shore up the banks will mean they will be controlled by the Greek state, which sparked the sovereign debt crisis when the government of then- Prime Minister George Papandreou revealed that the country’s deficit was twice what was previously disclosed.

Without ultra transparency, why would any private investor invest in the Greek banks when they cannot independently assess the risk of the banks?

Clearly, the private investors are looking for the Greek government to 'guarantee' their investment -- the Greek government will take the risk of loss and the private investors will pocket most of the gains.

Pumping funds into the banks may become a campaign issue as parties vie to win votes from an electorate that partly blames banks for tax increases and also for spending cuts the nation is having to endure to keep Greece in the euro.

Pumping funds into the banks should be a huge campaign issue given that the banks do not need the funds today and can retain future earnings to rebuild their book capital.

Given this basic fact about modern banks, voters have to wonder why politicians are keen on giving private investors and current bank shareholders a deal.