Publication of the Interim Financial Stability Report of the Bank of Greece
23/12/2009 - Press Releases
Today, the Bank of Greece published its Interim Financial Stability Report, covering the period from June 2009, when the previous Financial Stability Report was published, to November 2009. These reports discuss and assess factors relevant for the stability of the financial system. Today's Interim Report is comprised of the following chapters:
I. Overview of trends and general assessment
ΙΙ. The macroeconomic environment
III. Money and capital markets
IV. The banking sector
V. Other financial intermediaries
- Special features
A box in Chapter I provides a brief update on developments in the Greek banking sector as at end-September, while another box in Chapter IV discusses the role and importance of credit information systems, focusing in particular on Tiresias SA and explaining its purpose and scope. The "Special features" section provides background information on four topical issues:
• The work currently under way on a new financial supervision architecture in Europe;
• Pro-cyclicality as a result of the interaction between the financial and the real sectors of an economy;
• The link between funding liquidity risk and market liquidity risk;
• Deposit, investment and insurance guarantee schemes in Greece.
A. MAIN POINTS OF THE REPORT
Since the publication of the Financial Stability Report in June 2009, the factors determining the stability of the domestic financial system have worked in different directions:
• The signs of stabilisation in the global and European economy have had an effect in a positive direction, which was offset by the fact that Greece experienced a lagged economic downturn compared with other countries.
• The global money and capital markets are gradually returning to normal, amid some residual shocks and occasional surges in pressures, in particular for economies which are seen by markets as having to provide concrete proof of their willingness and ability to remedy their large fiscal imbalances and chronic structural weaknesses.
Given the current state of the international environment, reversing the unfavourable market sentiment is the key macroeconomic policy challenge facing Greece. The ability of the domestic economy to keep pace with, and exploit the opportunities offered by, the incipient global economic recovery, as it takes hold, will depend crucially on the speed at which fiscal imbalances are corrected and the confidence of households, business firms, markets and the international community in the country's fiscal outlook and growth potential is restored. Success with restoring confidence will also determine the ability of the domestic financial system to maintain, also in the future, the remarkable resilience it has exhibited even in the most difficult periods of the global crisis.
Unlike what is the case in many other countries, the causes of the Greek economy's problems do not originate from the banking sector or its linkages with the global financial system. The data available so far confirm that, despite the negative impact of the macroeconomic environment and the market sentiment, the key aggregates of the Greek banking sector have remained fundamentally sound and do not per se pose risks to financial stability. However, the continuing volatility of international markets and second-round effects from domestic economic developments call for vigilance.
In advanced economies there are growing signs of a forthcoming recovery, albeit a mild and gradual one, while in the emerging economies of Asia, activity is intensifying. Overall, however, it seems that the recovery of the global economy in 2010 will be rather slow. The global financial system has not yet fully returned to normality. It will also take time before we can see the full impact of the unprecedented non-standard measures implemented by governments and central banks to offset the negative feedback effects between the financial and the real sectors of the economies.
The emerging economies, including the countries of Southeastern Europe, have faced significant challenges this year. The threat of "twin" crises (a banking and a balance of payments crisis) in these countries has been averted in a timely manner. Decisive factors in preventing the worst scenarios from materialising were, on the one hand, the economic measures taken by most of these countries and, on the other, the support of the international community via relevant international organisations and foreign credit institutions operating in the region. Yet, although the imbalances were contained, the short-term economic outlook of the region remains vulnerable, which points to an urgent need to press ahead with the necessary structural adjustments, in order to ensure that the economies in the region get back on the track of strong and sustainable growth.
The period after the first quarter of 2009 saw a gradual abatement of pressures on the stability of the domestic financial system coming from developments in international money and capital markets. The tentative signs of an improvement in money market conditions, which emerged in the second quarter of 2009, became clearer during the months from July to November. However, although the generalised market tensions have eased, country- and case-specific pressures remain. A crucial contribution to the easing of tensions in the euro area was made by the Eurosystem's enhanced liquidity support measures. Also positive, to some extent, was the impact of developments in bond and equity markets. However, the volatility that was observed in some markets during October and November and intensified in December, acted as a reminder of the need to effectively address the deeper causes of such volatility.
The subdued economic activity in Greece during 2009 has weighed heavily on the net financial position of non-financial corporations and households. On the other hand, there has been some alleviation of the burden of corporate debt servicing, partly due to the decline in bank lending rates, which was significant overall during the year, but occurred gradually and was accompanied by a tightening of credit standards.
B. THE KEY AGGREGATES OF THE BANKING SECTOR
The above developments inevitably affected the financial results and indicators of the banking sector. Overall, the considerable decline in profitability observed in the first half of 2009, relative to the same period of 2008, continued into the third quarter of 2009. Between January and September 2009, in comparison with the corresponding period of 2008, the pre-tax profits of Greek banks and their groups fell by 38.6% and 42.3% respectively, while the exposure to credit and market risk increased. At the same time, there has been a small decrease in liquidity risk, as well as a rise in capital adequacy ratios.
Lower profitability was primarily due to considerable higher loan-loss provisions. On the other hand, profitability benefited markedly from the favourable conditions prevailing in capital markets, which allowed an increase in net income from financial operations, at a time of declining net interest and commission income. During the period reviewed, the performance of banks and their groups also benefited from reduced funding costs (reflecting the liquidity support measures of the ECB), as well as from the measures taken by the government in order to enhance liquidity in the economy (Law 3723/2008).
As a result of the worsened financial situation of firms and households, the non-performing loans to total loans ratio (NPL ratio) rose to 7.2% in September 2009, although the pace of increase decelerated during the year (second quarter 2009: 6.8%, first quarter 2009: 6%, December 2008: 5%). The increase in NPL ratios was broadly-based and affected all loan categories. The coverage ratio (i.e. accumulated provisions over NPLs) also fell visibly. Against this background, it becomes imperative that banks increase provisioning and pursue prudent profit distribution and bonus policies.
The liquidity of the Greek banking system improved during the reviewed period, as reflected in the evolution of compulsory liquidity ratios and the downward trend in the loan-to-deposit ratio. Underlying this improvement in liquidity ratios were, most importantly, banks’ recourse to the liquidity-providing operations of the Eurosystem and an enhancement of their deposit bases. In the next few months, it is important that banks diversify their funding sources and reduce their reliance on the Eurosystem for liquidity, weighing the alternative funding sources in a timely manner and in line with the ECB’s strategy for a gradual withdrawal of non-standard liquidity support measures.
Another very positive development during the year was the improved capital adequacy of Greek commercial banks and their groups, mainly as a result of a considerable increase in prudential own funds. At the end of September 2009, the capital adequacy of banks and their groups stood at 13.2 and 11.7 respectively (up from 10.7 and 9.4 at the end of December 2008). Particularly important from the viewpoint of banking system stability was also the improvement in the quality of own funds, mainly due to the completion of considerable capital increases in cash. In the current phase, it is essential that banks formulate a clear medium-term strategy, in particular with respect to the desirable level of their capital base and the use of alternative funding sources. In so doing, they should assess not only the current conditions, but also projected financial and macroeconomic developments and prospects, which are still surrounded by a high degree of uncertainty.
In view of the need to prudently deal with the consequences of the economic downturn in Greece and the other countries where they are active, Greek banks should maintain comfortable capital buffers, above the supervisory minimums, by increasing, inter alia, internal financing through retained earnings. In formulating their strategy, banks should also take into account the proposed changes in the international supervisory and regulatory framework. These changes will imply, among other things, increased quantitative and qualitative capital requirements, higher provisioning for credit risk and a more balanced mix of alternative funding sources.
C. DEVELOPMENTS AFTER THE PREPARATION OF THE INTERIM REPORT
Over the past three weeks since the finalisation of the Interim Financial Stability Report, some of the risks and challenges pointed out in the report have intensified. The developments on the aggregates of the Greek economy, have led markets to a reappraisal of the country's credit risk; thus, three rating agencies have downgraded the credit standing of Greece, which inevitably implies a reassessment of the credit standing of Greek banks. These developments are reflected in higher volatility and downward trends in the prices of Greek government bonds and shares listed in Athens Exchange. These trends should be reversed so that they will not hinder the implementation of banks’ planned funding programmes.
The full text of the Report (in Greek) is available on the website of the Bank of Greece and it will be available in English by the end of January 2010.