Opening remarks by Dimitris Malliaropulos, Chief Economist and Director of economic analysis and research at the "GBA Session on Non-Performing Loans", organized by the London Business School at the Bank of Greece.
11/09/2019 - Speeches
It is a great pleasure to welcome you today to the 2ndGBA session on Non- Performing Loans organized by the London Business School here at the Bank of Greece. Unlike last year, where the focus of the GBA session was on the banks’ role and the dynamics of the financial sector, the focus this year will be more on the role of NPLs as a driver of the Greek economy dynamics and as a source of opportunity moving forward.
The steep rise in NPLs in Greece over the past decade was largely the result of the economic crisis, particularly its depth and duration. Between 2008 and 2016, Greece lost over 25% of real GDP and the unemployment rate rose by nearly 16 percentage points. The deterioration in the macro-economy caused serious debt- servicing problems for households and businesses. NPLs rose substantially, weakening banks’ asset quality, thus making it difficult for banks to finance the real economy. In turn, the sovereign – bank loop has exacerbated the crisis.
Since the economy is the major driver of NPL dynamics, I will first try to provide an overview of the current state of the Greek economy and the banking sector. Then I will touch upon the main challenges for the Greek economy and the Greek banking system looking forward and explain why tackling the issue of NPLs is of high importance for the growth prospects of the economy and the health of the banking system.
Current state of economy and banking system
Economy: 2019 marks the third year of economic recovery in Greece following the great recession. Real GDP growth seems to have stabilized at around 2%, as bank financing remains scarce and expensive, not least because of the large stock of NPLs in banks’ balance sheets. Nevertheless, after a weak start in the year, the recovery of the Greek economy seems to be accelerating in Q2-Q3, despite the global slowdown. In particular, over the past few months, economic sentiment has increased to multiyear highs, bank funding and liquidity conditions have improved, real estate prices continued to increase and bond yields have declined significantly. Furthermore, confidence in the banking sector has improved substantially and capital controls were fully lifted on September 1st, after being effective for 50 months.
The July 7 national elections brought a new government in office. The new government has been elected on an ambitious reform agenda and a platform of business-friendly economic policies with a focus on accelerating reforms, speeding up privatizations, unfreezing large investment projects, attracting foreign direct investment and reducing taxation, while at the same time maintaining fiscal discipline and the agreed fiscal targets.
Short-term economic indicators suggest that the economy shows significant resilience to the global slowdown. This is due to the positive momentum as the economy emerges from a long-lasting recession, which, to a large extent, counterbalances the negative effect from the weakening of global activity. In particular:
- Economic sentiment has reached a 12-year high whereas consumer confidence has increased to a 19-year high.
- The recovery in the labour market continues for the fifth year, with growth rates of employment exceeding 2% y-o-y over the past three and a half years.
- Revenues from tourism in real terms increased at double-digit numbers during the first six months of the year.
- Second quarter 2019 GDP data suggest that growth has accelerated to 1.9% y- o-y (0.8% q-o-q) in Q2 relative to Q1, with the main drivers being net exports and public consumption. According to forecasts by the Bank of Greece, economic activity is projected to increase by 2.3% in the second semester of 2019 and by 1.9% in the year as a whole.
- Financial indicators have also improved substantially, suggesting increased confidence in the prospects of the Greek economy. In particular:
- Government bond yields have declined sharply since the start of the year. Corporate bond yields declined below 1% from more than 3% one year ago.
- Deposit inflows have continued as confidence in the Greek banking system improved.
- Bank credit to non-financial corporations increased in the first half of this year for the first time since 2011.
- House prices have increased for six quarters in a row after suffering significant declines since the start of the crisis. The recovery in house prices has accelerated in Q2 2019 (7.7% y-o-y).
Banking system: The liquidity conditions of Greek banks have improved substantially, as reflected in the elimination of ELA and the overall, significant reduction in total central bank funding. The decrease in central bank financing reflects a number of factors:
First, domestic private sector deposits have been on a constant upward path over the past three years, reflecting improved confidence in the stability of the financial system.
Second, Greek banks have improved their access to the interbank market and have increased their funding from other sources such as issuance of debt securities, loan-sales and securitizations.
Third, Greek banks’ eligible collateral for ECB monetary policy operations has increased substantially following the upgrade of Greek banks’ covered bonds to investment grade.Finally, the valuation of assets held by the banks increased considerably as GGB yields declined by about 300 bps since the start of the year.
Nevertheless, Greece faces a number of challenges looking forward:
- Given the country’s poor demographic outlook and tight budget constraints, achieving economic growth significantly higher than the current levels of 2% in the long term is a great challenge and requires structural reforms to boost productivity and investment.
- Tackling the problem of non-performing loans is critical to the health of the banking system and to its ability to finance investment and support the real economy.
Developments in Non-Performing Loans and challenges for Greek banks
Over the past three years to mid-2019, the stock of NPLs fell by more than €30 billion from its peak of €107 billion in March 2016, largely through write-offs and sales. Nevertheless, the stock of NPLs remains extremely high, at about €75 billion currently, equivalent to 43.6% of total outstanding loans in banks’ balance sheets. Regarding their structure, more than half of NPLs are business loans, one third are mortgages and about 10% are consumer loans.Banks have agreed with the SSM a set of ambitious targets for NPL reduction: NPL ratios are to fall to 35% by the end of this year, and close to 20% by the end of 2021. It should be noted, however, that even if these targets are met, Greek banks will have more than five times higher NPL ratios that the EU average.
Hence, it is important that a truly systemic solution, resembling an Asset Management Company, is implemented in order to complement the individual efforts of each bank to reduce NPLs.
Importantly, Greek banks have maintained satisfactory capital adequacy ratios, following three rounds of recapitalisation. Nevertheless, legacy NPLs impose a major constraint upon Greek banks’ profitability, hence, their capacity to generate capital internally.
Reducing NPLs drastically is also important for financing the recovery of the Greek economy. In fact, the high level of legacy NPLs acts as a constraint on Greek banks to extend much needed credit to the real economy. Based on past years’ experience, rapid economic growth cannot be achieved unless the banking sector can finance investment at an adequate level and at a reasonable cost. A substantial reduction of NPLs is a precondition for banks to improve their rating scores, thus allowing access to private funding at a lower cost which can be passed to companies and households in form of lower interest rates for bank credit.
Let me close with two last remarks regarding loan restructurings and reforms of the regulatory framework of NPLs:
Although sales, primarily through securitizations and loan write-offs are the main drivers of the NPL reduction so far, this should not lead banks to relax their efforts to successfully restructure the loans that are still in their portfolios. On this front, progress is rather slow and banks need to come up with improved long-term loan modification schemes so that the observed high rate of re- defaults is contained.
Finally, more work is needed to further improve the regulatory framework so as to remove bureaucratic obstacles and legal loop holes. The new regime of primary residence protection must fit into a single and permanent legal framework for the insolvency of physical persons, while the out-of-court work out regime must be radically reviewed.