Thursday, April 19, 2012

Issues delaying Greek bank recapitalization plan easily solved under Swedish model

A Wall Street Journal article highlights the key issues that must be resolved before a plan to recapitalize the Greek banking system can be put in place.

These issues are easily handled under the Swedish model for handling a bank solvency led financial crisis.  Confirming yet another advantage of the Swedish model over the Japanese model.

"The issue of the bank recap is moving slowly. The trick with the plan is to incentivize private investors," one senior government said. "We have to design the right incentive structure…I expect a decision to come after the elections."...
Under the Swedish model, the government does not invest in bank capital securities.  This includes contingent convertible bonds, preferred shares or common stock.

The government does not invest because the investment is not needed.  Banks are fully capable of retaining future earnings and paying banker bonuses in newly issued shares until such time as bank book capital levels have been rebuilt.

Private investors like this solution as it does not dilute their ownership or set up a situation where the government is involved in lending or operating decisions.  Even though the earnings are retained while the level of bank book capital is being rebuilt, their shares are not valueless.  There are plenty of example of non-dividend paying firms with stock that trades based on a discounted cash flow analysis.

By comparison, under the Japanese model, governments invest in bank capital securities to protect the level of capital at the bank.  This raises the issues of dilution and interference.
Last month, Greece completed much of a planned €206 billion ($270.4 billion) debt restructuring .... According to estimates, Greece's banks are facing a combined €40 billion in losses—equal to a fifth of the country's gross domestic product—from the debt restructuring as well as rising nonperforming loans. 
To restore their solvency, the four biggest lenders—National Bank of Greece SA, EFG Eurobank Ergasias SA, Alpha Bank AS and Piraeus Bank SA—will have fresh capital needs of €10 billion to €15 billion combined....
But with a combined market value of just under €3.3 billion, the lion's share of that capital will come from the Greek government, not from private investors....
Only under the Japanese model of protecting bank book capital levels today does the capital have to come from the Greek government.

Under the Swedish model, bank book capital levels can be rebuilt over time and effectively 100% of the capital would come from private investors.

The history of banks shows that modern banks do not need to rebuild their book capital levels today.

The largest banks in the US operated for years with negative book capital level if their loans to less developed countries were marked to market and continued to make loans.  The US Savings & Loans operated for years with negative book capital levels and continued to make loans.
According to the terms of Greece's latest bailout, the banks will have until September to raise the capital they need, as well as detail other plans to boost their capital, such as asset sales, cost-cutting or restructuring their loan books.
While these terms make sense to adherents to the Japanese model for handling a bank solvency crisis, they make no sense under the Swedish model or reality.

Consistent with the regulator induced credit crunch that has gripped the EU since the announcement of the 9% Tier I capital ratio target, these terms are also biased towards inducing a credit crunch.  The terms are concerned with a meaningless level of bank capital and not supporting economic growth in the real economy.

Under the Swedish model, the focus is shifted from bank book capital levels to continuing to make loans to support the real economy and cleaning up the bad assets.
But the key issue is how to reduce government meddling in the banks that the state will majority own—and what to do with those state-controlled shares in the future.... 
The solution is to adopt the Swedish model and don't have the government invest in the first place.
To minimize state control, Greece's troika of international inspectors—from the European Commission, the ECB and the IMF—have insisted that the banks remain under private management and have given the government between two and five years to unload their shares in the banks. 
If the holding period is only two to five years, why bother with the government making an investment at all?

Given Greece's limited access to the sovereign debt market, wouldn't the proceeds be better spent on stimulating the Greek economy?

Doesn't it make more sense to adopt the Swedish model and require the banks to provide ultra transparency?

By requiring the banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, market participants can assess the risk of each bank and see that it is addressing all of its bad assets.  This restores confidence in the Greek banking system without any investment from the government.

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