Speeches

Lecture by George Provopoulos Governor of the Bank of Greece, 17 May 2013, Bulgaria, Sofia: “The Greek economy & banking system: recent developments and the way forward”

17/05/2013 - Speeches

• Before I begin my presentation, I want to thank Governor Iskrov for inviting me to be here today.

• I must add that there are strong relationships between our countries at the commercial level, our institutions at the policy level, and between Governor Iskrov and myself at the personal level.

• These relationships have proven to be crucial during the crisis, providing important advantages for both Greece and the broader region.

Introduction

• My presentation will be structured as follows.

• I will begin by discussing some developments that led Greece into crisis over the course of the past decade.

• I will then take stock of the progress that Greece has made in adjusting its economy.

• Before discussing these issues, let me provide a brief preview of my two main conclusions.

• First, although we have been through some very rough waters in Greece, both in terms of the real economy and the banking system, the situation is now looking brighter for the following reasons:

- A coalition government is committed to the adjustment programme. It has stepped-up the pace of implementation and is delivering on the programme’s objectives.

- Official lenders are providing strong support to Greece, enabling the country to carry-out the necessary restructuring of its economy, including its banking system.

- Moreover, the euro area is addressing the flaws in the original institutional design of the monetary union, enabling it to both prevent crises in the future and to better manage them, should they occur.

• Second, a considerable amount of progress has been made in addressing the structural weaknesses of the Greek economy, making it much more competitive. Importantly, the country is well on the way to building a strong and competitive banking system.

• I must add, that as the Governor of the institution responsible for banking supervision and financial stability, I gain a great deal of satisfaction from the fact that, after three years of deep crisis, the stability of the banking system has not only been preserved -- not a single depositor has suffered a loss -- but it has strengthened.

• As a result of this progress, the groundwork is being laid to underpin a sustainable, robust economic recovery.

• I will now discuss in some detail the underlying causes of, and the policy responses to, Greece’s sovereign debt crisis.

 

Greece’s macroeconomic imbalances and the crisis

• The entry of Greece into the euro zone in 2001 was widely seen as marking a transformation in the country’s economic performance, which for many years had been characterized by weak growth and high inflation.

• Following the adoption of the euro, growth picked up sharply, averaging almost 4 per cent a year during the period 2001 to 2008.

• At the same time, the interest rate spread between 10-year Greek and German sovereigns dropped from over 600 basis points in the late-1990s to between 10 to 50 basis points in the years following adoption of the euro.

• Over the period 2001 to 2009, however, fiscal and external imbalances were building up to unsustainable levels.

• Fiscal deficits consistently topped 5 per cent of GDP, peaking at about 15 ½ per cent at the end of the period.

• The share of government debt in GDP rose from about 100 per cent at the beginning of the period to 130 per cent at the end of the period.

• Competitiveness, measured in terms of unit labor costs against Greece’s major trading partners, deteriorated by 30 per cent during the period.

• The loss of competitiveness, and the relatively-high growth rates, led to a widening of the current-account deficit from 7 per cent of GDP at the time of entry into the euro area to a peak of 15 per cent in 2008.

• These large and growing imbalances should have sounded loud warning alarms to the financial markets, but they did not do so for some time.

• Although some major countries were hit by the global financial crisis that erupted in the summer of 2007, Greece was relatively unaffected.

• Despite relatively low spreads on Greek sovereigns following the outbreak of the global financial crisis, as early as in 2008 the Bank of Greece began warning the Greek authorities and the public of the dangers inherent in the twin deficits.

Outbreak of the crisis

• These dangers became evident -- belatedly -- to the financial markets in the fall of 2009 with the news that the fiscal deficit for that year would be much higher than had been earlier projected, undermining the credibility of the Greek authorities.

• Interest-rate spreads began a relentless upward climb, reaching 1,000 basis points in the spring of 2010, and the sovereign became cut off from the global financial markets.

• In May 2010, the Greek government agreed to an adjustment programme with the IMF and Greece’s euro-area partners in order to meet its financing needs.

• This adjustment programme was built around two key pillars.

- Fiscal consolidation

- Structural reforms (including privatizations and measures to combat tax evasion)

• The government placed exclusive emphasis on the first pillar. Moreover, the fiscal mix relied more on tax increases than on spending cuts.

• The Bank of Greece had advised that the mix should include 1/3 revenue increases and 2/3 spending cuts.

• Fiscal consolidation led to a recession that was much deeper than expected, especially since it relied heavily on increases in tax rates and was not combined with structural reforms to boost growth prospects.

• At the same time, lack of implementation of the programme’s second pillar --structural reforms -- undermined the government’s credibility. This led to increased uncertainty.

• What had started out as a sovereign debt crisis spilled over to the banking system, creating a second storm front.

• Prior to the outbreak of the sovereign crisis, the banking sector had sound fundamentals -- with high CARs, low loan-to-deposit ratios, and essentially no toxic assets of the kind that set-off the 2007 global financial crisis.

• In Greece, the size of the banking sector at the outset of the crisis -- at 200% of GDP -- was much smaller than in some other countries that experienced crises.

• In contrast to what happened in other countries, in Greece it was the sovereign crisis that led to a banking crisis, not the other way around. How did that happen?

• First, in terms of liquidity. A series of sovereign downgrades, and then bank downgrades, forced the banks out of the global financial markets.

• Uncertainty led to large deposit outflows (amounting to about 1/3 of the initial deposit base in less than three years).

• Banks had to resort to central bank funding, at first through Eurosystem monetary policy operations, but gradually, due to the lack of eligible collateral, to emergency liquidity assistance (ELA) from the Bank of Greece, at a higher cost.

• Following the PSI last year, banks took huge one-off losses on their bond portfolios.

• At the same time, the recession led to a continuous increase in non-performing loans.

• What started out as a liquidity problem threatened to turn into a solvency problem.

• The twin crises generated negative feedback loops, creating a general crisis of confidence, compounding the problems faced by the banking system, and exacerbating the contraction in GDP.

• But a contracting GDP meant a shrinking denominator in the debt-to-GDP ratio. As a result, the debt dynamics worsened, and the crisis became self-fulfilling.

• Last year, Greece was said to be on the road to the unthinkable -- an exit from the euro! The markets even had a name for it; they called it a GREXIT.

• The talk of GREXIT further undermined the economic and financial position of the country. It created currency risk, which, combined with sovereign risk, pushed spreads up to unheard-of levels.

• Early last year, spreads peaked at 4,000 basis points as the Greek government restructured its debt and agreed to a second adjustment programme.

• What about the effects on the economy?

• Between the end of 2008 and the end of last year, real GDP had fallen by more than 20 per cent.

• It is projected to fall by another 4 ½ per cent this year.

• The unemployment rate has risen from under 8 per cent to 27 per cent.

 

Adjustment: Fiscal

• Yet, as I mentioned at the outset, the future is now looking brighter. Why do I believe this? Let me explain.

• Consider, first, fiscal adjustment.

• From 2009 to 2012, the fiscal deficit was reduced by some 9 percentage points of GDP.

• The structural fiscal deficit -- that is, the deficit that corrects for the business cycle -- has shrunk by 15 percentage points of GDP.

• The primary fiscal deficit -- that is, the deficit that excludes interest payments -- was 10½ per cent of GDP in 2009. It is projected to swing into a small surplus this year.

• What makes these achievements especially impressive is that they have taken place despite a contracting economy, which creates moving targets for fiscal consolidation.

• Greece’s fiscal consolidation is one of the largest ever achieved by any country at any time. In gross terms, fiscal-adjustment measures amounting to 20 per cent of GDP were implemented between 2010 and 2012.

• Additional fiscal measures, amounting to 11½ per cent of GDP, are being implemented in 2013 and 2014. These measures will increase the primary fiscal surplus to 3 per cent of GDP in two years.

• The new measures place emphasis on expenditure cuts to reduce the size of the government sector and allow the tradables sector to expand, so that exports can help generate growth.

• Moreover, the decisions of the Euro group last November -- including the debt buyback, lower interest rates, and longer maturities on official sector loans -- are exerting a positive influence on the debt dynamics. As a result, the debt ratio is on a path that will bring it below 110 per cent of GDP in 2022.

• I should add that a major reform of the pension system -- already been carried-out -- will also contribute to an improvement in the debt dynamics.

• Further debt-reducing measures were announced last November, subject to Greece fulfilling certain conditions. These measures would include further interest rate reductions, once Greece reaches an annual primary surplus, which the government expects to achieve this year.

 

Adjustment: External

• Consider, next, external adjustment.

• As I mentioned, Greece had lost about 30 per cent in terms of cost competitiveness against its major trading partners in the period from 2001 to 2009. Since 2010, about 80 per cent of that loss has been recovered.

• By the end of this year, the entire loss --and more -- will have been recovered.

• Competitiveness is also being promoted through structural reforms, which have increased the flexibility of labour and product markets.

• After many delays, positive signs are emerging with respect to tax evasion and privatizations.

- A new tax law aimed at combating tax evasion was passed earlier this year.

- Privatizations, amounting to €2.6 billion, will take place in 2013 (including real estate assets, the DEPA Group (gas), the Hellinikon site, and infrastructures such as ports and regional airports).

- The state lottery has recently been sold for over €700 million.

• As a result of these improvements in competitiveness, a rebalancing of the Greek economy is taking place. The share of exports of goods and services in GDP rose from 18 per cent in 2009 to 25 per cent in 2012. It will continue to rise.

• The current account deficit, which reached 15 per cent of GDP in 2008, fell to less than 3 ½ per cent last year. It will continue to fall.

The banking sector strategy

• I now turn to the banking sector.

• As I mentioned, what had started out as a liquidity problem in the banking sector threatened to turn into a solvency problem.

• We had to step-in to preserve banking system stability.

• The first step was to calculate the amount needed to recapitalize the banking system.

• The determination of the losses on the bond portfolios was pretty straightforward. What was challenging was to calculate, in a conservative manner, all possible losses on the loan portfolios of Greek banks in the coming years.

• For this purpose the Bank of Greece used BlackRock Solutions.

• Once BlackRock finished its work, most pieces were in place for the calculation of the capital needs of banks.

• The second part of our strategy was to assess which banks were good candidates for recapitalization by the Hellenic Financial Stability Fund.

• The Bank of Greece, in association with Bain, conducted a “viability assessment”.

• The result of the “viability assessment” was that the four largest banks, now called “core banks”, were assessed as eligible for recapitalization with public sector funds. These banks were assessed as the most likely to repay such capital within a reasonable timeframe.

• The non-core banks were given time to raise private capital by end-April. Those that failed to do so, will be resolved, i.e. their “good assets” will be absorbed by core banks.

• Turning to the total needs of the banking system, these were determined as the sum of: (1) the amounts needed for the recapitalization of core-banks (€28 billion); and (2) the amounts needed for the resolution of non-core banks (€17 billion).

• To complete the financial envelope, i.e. the amount of backstop needed for the recapitalization and restructuring of the banking system, we estimated a buffer of €5 billion to cover unexpected, adverse developments.

• Given the total financial envelope of € 50 billion, a few factors may work to increase the buffer, including synergies from the consolidation of the banking sector and the participation of the private sector in capital increases.

• There are also factors that may decrease the buffer, for example, a further deterioration of the loan portfolio, that is, beyond the already very conservative estimates by BlackRock, or a further reduction of pre-provision profitability.

• However, all updates and robustness analyses, conducted by my staff and shared with the troika, strongly suggest that the buffer will be adequate.

• When our exercise started there were 17 banks in operation: four core banks and thirteen non-core banks. [There were also a number of cooperative banks, the combined market share of which was only 1 per cent of the banking system.]

• So far, the resolution framework has been used to resolve 8 banks: five commercial banks (two of which were large and state-owned) and three cooperative banks.

• Consolidation is progressing. A core bank (Piraeus) absorbed three banks (two foreign subsidiaries and the state-owned Agricultural Bank).

• More recently, during the recent turmoil in Cyprus, that bank also absorbed the branches of the Bank of Cyprus, Laiki Bank and Elliniki Bank in Greece. That purchase helped stem any contagion from the Cypriot banking system to the Greek financial system.

• Alpha bank, the third largest core bank, has absorbed Emporiki bank, a fairly large subsidiary of Credit Agricole.

• The banking sector strategy is nearing its completion.

• All core banks have now concluded corporate decision-making processes to increase their capital by the amounts required -- a private sector threshold of 10 per cent for private sector participation -- by the Bank of Greece.

• Three of the banks (NBG, Alpha and Piraeus) are likely to be successful in raising 10 per cent of their capital needs through the market, so that they will remain under private control. The remainder of their capital is fully subscribed by the HFSF.

• Eurobank is being recapitalized directly -- and solely -- by the Hellenic Financial Stability Fund.

• Shortly, we will end up with four well-capitalized core banks and a few non-core banks.

• As a result, the Greek banking system is becoming more compact and efficient, eliminating excess capacity and exploiting synergies and economies of scale. It is becoming stronger and is well-capitalized.

• I must add that I am extremely satisfied that, having survived such an enormous economic and financial storm, the Greek banking system is emerging stronger so that it will be able to finance the recovery of the real economy.

Other developments

• The recent progress that Greece has made in restructuring its economy reflects, in large measure, the determination of the 3-party government, spanning the centre of the political spectrum, to take ownership of the adjustment programme.

• The coalition government has made it clear that Greece’s future lies within the euro zone.

• The benefits of the country’s adjustments extend beyond the credibility and competitiveness effects of the lowered macroeconomic imbalances.

• The adjustments mean that Greece will continue to receive financial support from official lenders, so that it can complete the process of restructuring its economy and banking system.

• Over the period 2010-14, Greece will have received loans totaling € 237 billion, of which € 43 billion remain to be disbursed.

• In light of recent loan disbursements, the coming months will see further liquidity impulses into the economy.

o The government is kick-starting major infrastructure projects that will create jobs.

• In addition, business projects and infrastructure are being financed by EU structural funds and the European Investment Bank. In 2013, around € 5 billion is expected from structural funds alone with a further € 11 billion during the period 2014-2016.

• With the banking system recapitalized and restructured, it will be in a position to resume its role as the main source of financial intermediation, supplying funds to support real economic activity.

The euro area’s response to the crisis

• And what about the euro area as a whole? Here, there are 2 important factors at work that will make the euro area a stronger monetary union.

• First, just as the Greek economy is undergoing a major restructuring to make it a stronger, competitive economy, similar processes are occurring in other peripheral economies, including Ireland, Portugal, Spain, and most recently, Cyprus.

• Second, work is also under way to make the euro area a more complete monetary union, with:

- strong economic governance;

- procedures to prevent macroeconomic imbalances from emerging;

- strong backstops -- including the ESM and Outright Monetary Transactions by the ECB -- to prevent future crises; and

- concrete steps towards the creation of a banking union.

Conclusions

• I have painted a picture of a Greek economy that is undergoing a major restructuring and I have argued that Greece has weathered its crisis.

• This judgment is not only my own. It is shared by the financial markets and the public.

• Consider the following developments.

• Since the peak of the crisis last June,

- Equity prices have more than doubled.

- Bond spreads have fallen by more than 2,000 basis points.

- Deposits of the private sector have increased by about 12 per cent.

- Hoarded banknotes -- a key sign of uncertainty -- are returning to the banking system. Some € 10 billion have been returned so far, and we expect another € 15 billion to return as the situation continues to normalize.

- Reliance of Greek banks on Eurosystem financing is down by almost 35 per cent.

• As the overhaul of the Greek economy continues, I expect economic growth to resume starting in the first part of 2014, if not sooner. In turn, as growth returns, Greece will become increasingly attractive as a destination for foreign investors!

• Let me conclude by saying that, despite predictions to the contrary, there has been no Grexit from the euro.

• Instead, I recently saw the word GREXIT had been replaced by the word GRECOVERY -- that is, an exit of Greece not from the euro, but from the crisis – a recovery.

• As usual, the markets are right, but a little late!

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