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Publication of the Financial Stability Report of the Bank of Greece

23/06/2009 - Press Releases

Τhe Bank of Greece today is publishing for the first time a separate "Financial Stability Report", inaugurating a practice that in recent years has appeared increasingly higher on the agenda of central banks worldwide. Such reports typically assess the soundness and the resilience of the credit system as a whole (macro-prudential supervision) as opposed to those of individual institutions --banks or other entities -- operating in the system (micro-prudential supervision). The Bank of Greece's Report provides, among other things, the results of recent stress tests for the Greek banking sector.

The aim of the Report is to highlight and assess any factors that could potentially threaten the ability of the financial system to absorb exogenous shocks and to prevent endogenous ones. The Report aspires to serve as a source of timely and reliable information on these issues and as a channel for an exchange of views with the other relevant public authorities and bodies, the entities subject to Bank of Greece supervision, the social partners and the general public.

Financial stability can be defined as a condition in which the financial system as a whole – comprising banks and other financial intermediaries, money, credit and capital markets and market infrastructures (payment and clearing and settlement systems) – is resilient and able to withstand any unexpected shocks or unwinding of imbalances, thus minimising the likelihood of disruptions which are severe enough to jeopardise the efficient allocation of savings and the smooth flow of money and credit into the socially most beneficial uses and activities.


A. The financial landscape

Uncertainty about the future path of the global and European economy remains high, despite some encouraging signs. The global recession has negatively affected domestic economic activity, and hence also the financial situation of Greek enterprises and households. In 2008 the tightening of banks' credit standards for lending to non-financial corporations and households restricted the supply of credit, while the weakening of consumer and business confidence and the resulting lower propensity to consume, invest and assume risks caused credit demand to decline as well. A positive effect is expected to come from the gradual abatement of tensions in the money market that is visible today.

Corporate profitability declined considerably in 2008, while firms' indebtedness and debt servicing costs increased. However, the large majority of firms serviced their debt obligations to banks in a timely fashion. For 2009, a positive effect on the financial situation of enterprises will be exerted by the gradual decline in lending rates that began in late 2008, while the contraction of economic activity will likely squeeze profitability, with potential negative repercussions on business firms' debt servicing ability.

Turning to households, during 2008 their indebtedness rose, but less than in previous years, because of, on the one hand, the increased unwillingness of households to assume additional debt obligations and the tightening of credit standards by banks on the other. For 2009, the assessment is that the decline in interest rates will reduce debt servicing costs; however, the expected evolution of incomes and of the value of household wealth may make it more difficult for households to service their debts and warrants vigilance.

Developments in money and capital markets were another source of pressures on the stability of the financial system in 2008. For a prolonged period of time, financial institutions were unwilling to lend through the interbank market, because of a general lack of trust and uncertainty about the solvency of counterparties. The extensive liquidity-providing interventions of the ECB and the cuts in monetary policy rates, from October 2008 onwards, helped to gradually mitigate, without however completely eliminating, the tensions in the interbank and other markets.

Β. The key aggregates of the banking sector

The deterioration of global financial and macroeconomic conditions has had a negative impact on the key aggregates of the banking sector in Greece, although to a lesser extent than in other countries. In 2008 the exposure of Greek banks to credit and liquidity risk increased. Profitability fell considerably, while capital adequacy also declined. Those negatives trends continued into the first quarter of 2009. Overall, however, the key aggregates of the Greek banking sector remain fundamentally sound and continue to provide a satisfactory margin of safety for covering risks and ensuring financial stability. In this respect, the concluding statement of the recent IMF mission to Greece points out that "the authorities' response to the financial crisis has been appropriately pro-active..." and that "the banking system appears to have enough buffers to weather the expected slowdown". The Bank of Greece will continue to call upon banks both to fulfill their obligations in terms of the smooth financing of the economy and to pursue appropriate policies to ensure financial stability.

In 2008, the financial and macroeconomic environment had an adverse impact on the key aggregates of the banking sector. In December 2008, compared with one year earlier, the sector's exposure to credit risk increased. The ratio of non-performing loans to total loans (NPL ratio) rose to 5% (2007: 4.5%), mainly because of increased non-performing housing and consumer loans, while the ratio of provisions for credit risk to non-performing loans (NPL coverage ratio) declined to 48.9% (2007: 53.4%). However, the exposure to individual borrowers and the concentration of loans to particular sectors of the economy remained low, while banks have substantially increased, in absolute terms, their contingency provisions for any losses from their domestic and foreign lending portfolios. The liquidity risk of the banking sector as a whole increased because of the tensions in money markets and Greek banks' activity in foreign markets, most notably in countries of Emerging Europe; the latter were more strongly affected by the global financial and economic crisis than the Greek economy. Greek banks' activity in these countries equals about one fifth of Greek GDP. By contrast, a decline was observed in market and operational risk, which are only a small part of total risk.

In 2008 the pre-tax profits of Greek banks and banking groups fell sharply (banks: -72.4%, banking groups: -39.2%). The main factors behind this development were the more than doubling of provisions for credit risk, the losses from financial operations and the reduction in interest income. The profitability and capital adequacy indicators of banks and banking groups dropped considerably below their pre-crisis levels. Despite these declines, these indicators continue to provide a satisfactory margin of safety for addressing risks and ensuring financial stability. However, constant vigilance is warranted, especially in the light of the continued downward trend in these indicators over the first quarter of 2009.

The evolution of banking aggregates in the first quarter of 2009

The trends observed in 2008 continued into the first quarter of 2009. The non-performing loans (NPL) ratio, at bank level, rose appreciably to 6%, an increase that was broadly based across all categories of loans, and caused the provisions-to-NPL ratio to fall to 43.7%. Although this ratio does not take into account the sizeable guarantees and collateral held by Greek banks, its continued decline points to a need for increased vigilance.

Between the first quarter of 2008 and the first quarter of 2009, pre-tax profits dropped considerably (banks: -85.3%, banking groups: -51.3%). This outcome was attributable to the more than doubling of provisions for credit risk and to a decrease in net interest and fee income. A positive contribution was made by profits from financial operations and from the investment portfolio, while the increase in operating costs was contained. However, it should be stressed that, if the valuation adjustments recognised directly in the net position were taken into account, banks would have recorded losses for the first quarter of 2009 (banks: losses of €200 million versus profits of €50 million euro, banking groups: losses of €120 million versus profits of €431 million).

The net interest rate margin fell by about 50 basis points (mainly because of the increased cost of funding from the fourth quarter 2008 onwards, as well as to the slowdown in credit expansion) and the return on equity fell by about 10 percentage points. Declines, of about 40 and 20 basis points respectively, were recorded in the Capital Adequacy and Tier I ratios. These outcomes stemmed exclusively from a decrease in regulatory capital, as the risk-weighted assets remained broadly unchanged. Yet, the capital adequacy ratios remained above the minimum acceptable levels.

C. The recent stress tests for the Greek banking system

Encouraging results were reached by the stress tests which were conducted by the Bank of Greece, using hypothetical scenarios commonly agreed with the International Monetary Fund. The purpose of the exercise was to assess the resilience of the Greek banking system to unexpectedly strong exogenous shocks and banks’ ability to cope with such shocks. The results have shown that the banking sector is able to withstand very strong shocks, whose probability of occurrence is very low.

The exercise involved assessing the impact of an extremely adverse macroeconomic scenario for Greece, assuming a cumulative decline of 3% in GDP over a two-year period, a rise in the unemployment rate of 4 percentage points and a 400 basis points increase in bank lending rates. These assumptions were integrated into an econometric model in order to estimate the consequences for non-performing loans (NPLs) in Greece. The total impact generated from these three risk factors, in the event that all three assumptions were to be valid simultaneously, was an estimated rise in the NPL ratio, at the banking system level, from 5% on 31 December 2008 to 12.7% by 31 December 2010. In order to estimate the ratio of non-performing loans to overall loans to the emerging economies of Europe where Greek banks have active presence, an even more adverse scenario was assumed. These countries were grouped into three risk categories, and NPL ratios at the end of the two-year period were assumed to be 20% for high-risk countries, 15% for medium-risk countries and 12.7% for low-risk countries, the same as that assumed for Greece. On the basis of these assumptions, the average NPL ratio for loans to these countries would almost quadruple in comparison with end-2008; in certain cases it would even rise tenfold.

In addition to credit risk, the implications of an extremely adverse scenario for market risk were estimated. This scenario assumes, relative to the actual figures of 31 December 2008, a parallel upward shift in the yield curve by 300 basis points, a 30% depreciation of the euro vis-à-vis the other major currencies, a 40% drop in the Athens Exchange composite index of stock prices and an increase of 450 basis points in the spread of the ten-year Greek government bond over the corresponding German bond. Banks' ability to absorb any losses arising from those adverse scenarios within the two-year period depends largely on their profits (before provisions) during the same period. For the purposes of the exercise, it was assumed that profits before taxes and provisions would fall by 15% in 2009 in comparison with 2008, before rising by 10% in 2010.

The stress test was conducted on a sample comprising the nine largest banks, which have a total market share of more than 80% (in terms of assets). The results of the exercise indicated that the Greek banking sector as a whole would be able to withstand shocks as adverse as those envisaged in the hypothetical scenarios. The assumed profits for the two-year period, the improved capitalisation through the use of the arrangements of Law 3723/2008, along with banks' provisions accumulated by 31 December 2008 would absorb a sufficient part of the estimated loss from all risks to ensure that the weighted average of the Tier I own funds ratio for the nine banks in the sample would stand at the satisfactory level of 8.62%, i.e. it would still exceed the threshold of 8% even under the strongly adverse assumptions of the scenarios.

It should be noted that the above-mentioned scenarios were applied to actual outturns as at 31 December 2008, which reflect some of the impact of the crisis. Clearly, the results are not homogeneous across banks. The median Tier I ratio is 9.1% and the majority of banks maintains a satisfactory capital base, even after the absorption of losses resulting from the hypothetical scenarios. However, for a very small number of banks, the absorption of losses of the magnitude estimated in these scenarios would imply a weakening of their capital base; this, however, would not cause any systemic risk, i.e. it would not threaten the stability of the financial system as a whole.

Finally, the sample banks were also stress-tested for liquidity risk, assuming a withdrawal of 10% of customer deposits and non-renewal of 50% of wholesale funding. The purpose of this exercise was to assess individual banks' capability to meet their financial obligations that mature over a horizon of one month. The results indicated that none of the banks in the sample would face difficulties in repaying its debt.

The Bank of Greece will continue to conduct stress tests in the future, compare their results with actual outcomes and take corrective action whenever it deems it appropriate to do so. In matters of banking supervision and financial stability, there is absolutely no room for complacency.

The full text of the Report in Greek is available on the Bank's website . The English translation of Chapter I of the Report is available here.

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