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Silvia Merler, affiliate fellow at Bruegel, Interview to Christina Vasilaki

It is necessary to address the problem of non-performing loans (NPLs) so as for the banks to be able to finance the real economy again, according to Silvia Merler, Affiliate Fellow at Bruegel think tank who offered her insights in an interview to the Crisis Observatory. Referring to the forthcoming recapitalisation of the Greek banks, Silvia Merler points out that this development will contribute to restoring the confidence of depositors and investors; nevertheless, in order for this goal to be feasible, it is even more important to overcome the uncertainty that prevails in the Greek political scene.

The latest deal between Greece and the EU foresees 10-25 bil for potential recap of the greek banks. Why do you think that another recap of the greek banks is needed?

Greek banks were found to be solvent and well capitalised in the ECB’s Asset Quality Review, but since then the economy has deteriorated and the level of Non-Performing Loans has increased, thus questioning the assumption of solvency. The quality of capital is also put at risk by the heavy reliance of Greek banks on Deferred Tax Assets instruments.

What was the cost of the capital controls for the greek banks?

I think it is extremely difficult to come to an estimate of this at the (relatively early) stage, because it would entail both direct and indirect effects (via the impact on the economy and consequently on NPL) which is difficult to estimate. The latest data we have from the Bank of Greece on NPLs is from end-2014, and at that time, things were improving in the sense that NPL were still growing compared to 2013 but at a slower pace. But I personally don’t think this improvement continued into 2015.

 Are the greek banks insolvent or lacking liquidity? Do you expect any resolution or merging?

The boundary between illiquidity and insolvency is very thin and blurry (as we also saw in the case of the Greek State itself). Greek banks are certainly lacking liquidity at the moment; due to the bank run that started this summer and that ultimately justified the introduction of capital controls. However, the increase in NPLs and the heavy reliance on DTAs can also question their solvency. There has been no explicit talks of consolidating the sector until now, as far as I can recall, I think whether this is a possibility will become clearer after we know the results of the ECB’s assessment.

 Is it possible that the recap infringe any EC rules on state aid?

If occurring in the way that has been discussed over these months, it would not. . If the recapitalisation of the Greek banks will be carried out before January 2016, then the framework is given by the amended State Aid framework. This states that before injecting public funds into banks, there needs to be bail-in of the junior debt but not necessarily beyond that. Haircut of senior debt is not mandatory, although one state could in principle decide to do it. I think we need to wait for the actual numbers coming out of the ECB assessment to know what the final plan will be, but what it is discussed so far was pretty much an application of the State Aid mechanism along with a very strong emphasis on the fact that uninsured deposits will not be touched. After January 2016, the BRRD bail-in would apply instead, according to which  bail-in of 8% of the institution's total liabilities including own funds must occur before public capital injection (so it would almost certainly include senior debt).

 What are the expected results of the recap of the greek banks so that confidence to the greek banking system can return (both depositors’ and investors’)?

We have seen that confidence especially in the banking systems can be very volatile, independently from the level of capital (the ECB AQR last year did conclude that the banks were very capitalised). I believe that a solid recapitalization will be important, but the most important thing for the return of depositors and investors’ confidence will be resolving the uncertainty that is dominating Greek recent political developments.

What really needs to be done in order for the greek banking system to start again financing the real economy?

I think that for Greek banks to be able to really re-start financing the real economy the problem of NPLs that weigh on their balance sheets needs to be addressed. This is partly related to the economic developments (a growing economy helps dealing with NPL and makes the accumulation of future NPL less likely) but to deal with the stock, some form of bad banks could certainly be helpful. The Irish and Spanish banking sector programmes had that component, although the kind of problems in the Spanish and Irish banks were quite different from those of the Greek banks.

 How would a bad bank work?

Basically in both cases (the Spanish and the Irish) banks were able to clean up their balances by shifting the bad assets in the bad bank. The real issues on bad banks is how to ensure they do not become very costly for the State, which ideally could be avoided if you manage tore-sell those assets at a decent value, which in turns lead us to the issue of valuation (what is the proper valuation of a non performing loan?), also key in the process.

 Finally, the privitisation fund will also include the shares in Greek banks after their recapitalisation. What will this mean in practice for the greek banks and also for the greek economy?

I think there is not yet enough clarity about the structure of this privatization fund to answer this in a definite way. Much will depend in fact from the structure that will eventually be adopted and on who the buyers would be.