Greece’s banks have been badly battered over the last several years by the nation’s economic depression, combined with a series of actions by the Greek government, often as a result of pressure from Europe. (For simplicity, I will refer to all the official sector creditors of Greece as “Europe”.) Not surprisingly, the banks need an infusion of additional capital to recover from existing losses and to be adequately prepared for potential trouble ahead. A group of international investors with substantial investments in the Greek banks has offered an interesting proposal. It’s clearly in their economic interest, but it appears likely to be in the interests of Greece and Europe as well, especially after negotiation to optimize the proposal.
I would like to make two points before laying out the proposal and the background to it. First, this discussion is about the overall idea. I am not endorsing a specific proposal and would not have the ability to judge the specific terms anyway. There would need to be negotiations between the various parties to find the best deal. Second, for the sake of transparency, please note that one of the investors is Wilbur Ross, who is a donor to Brookings and on our Board of Trustees.
The European Central Bank (ECB), which is the supervisor for large banks in the new European “banking union,” is currently running a “stress test” on the major Greek banks. Stress tests have become a standard approach since the global financial crisis to ensure that banks have the resilience to handle unexpectedly bad outcomes. Supervisors choose economic scenarios that they consider to be reasonable worst cases, meaning that they are unlikely but plausible. They then set required capital levels so that the banks would have sufficient margin for error to continue to operate effectively, even after suffering the future losses caused by these worst case scenarios. Given the Greek economic situation, the tests will certainly determine that more capital is needed.
Running these stress tests well and determining the right amount and form of capital to require as a result will be important for both Greece and for Europe. The Greek government has already invested 30 billion euros in these banks as part of a previous recapitalization. As part of this summer’s deal between the Greeks and Europe, the latter has promised to provide up to 25 billion euros of additional funds to be available for the new recapitalization. So, there is a lot of money at stake. Further, the health and activity level of the banks is important to Greece’s eventual economic recovery.
The default option for the stress test and recapitalization appears to be to take a very conservative view of potential losses and to inject new common equity, up to the 25 billion euro limit of the funds offered by Europe for this purpose. The stakes of existing shareholders, including the Greek government, would be very heavily diluted or completely wiped out.
The international investors, mostly American, have proposed a different approach. As I understand it, they suggest that a few billion euros of new common equity be injected up front, which they are willing to help supply on a pro rata basis with their current ownership percentages. The rest of the 25 billion euros of funds from Europe would be placed into a special fund which would be legally obligated to be injected as additional common equity under stated terms and conditions, essentially as required in the future by the ECB. The investors have suggested that the special fund receive a reasonable commitment fee and that the commitment end after two or three years, with any excess funds returned to the European institutions that supplied it.
A key argument of the investors is that Greece’s economic situation is extremely difficult to predict and that there are downsides to simply taking the pessimistic approach that the entire amount will really be needed as new capital. Most straightforwardly, the existing 30 billion euro investment by the Greek government would also be heavily diluted or wiped out, creating additional economic burdens on that nation. They contend that having the official sector make legally binding commitments to add further capital if it is needed, and to set aside the funds into a special vehicle, would provide the Greek banks the same amount of safety as infusing the capital up front.
Some version of this proposal seems better to me than effectively “nationalizing” the major Greek banks, if that is the right term for giving ownership to some mix of Greek and European official institutions. Greece already has an excessively large public sector, with a fairly poor performance record, which Europe is pushing the government to slim down. Finding a way to maintain substantial private sector involvement in the major banks appears to be a better solution since it may be a number of years before the nationalized banks can be re-privatized. If nothing else, it will help avoid the politicization of lending decisions that could easily occur otherwise, especially with a strongly left-wing government in power.
It is indeed very difficult to forecast the future of Greece’s economy and the resulting loan losses for the banks. It may be that most or all of the 25 billion euros of European funds will eventually be injected into the banks. In that case, the situation is essentially the same as without this proposal, except the losses will at least have been shared with the international investors who will have put some of their own money into the pot up front. If instead, little or no further capital is needed from the special fund, then all sides will have won. The investors will keep their stakes, Greece will face a lower burden of debt to repay, and Europe will get most or all of its funds back.
It is true that wiping out the private investors now could produce a windfall for the official institutions later if Greece avoids the worst problems and the banks can be reprivatized at a profit. However, this does not strike me as a good policy goal and I do not sense that Europe is eager to invest 25 billion euros in the Greek banks as a pure investment. Rather, the right goal seems to be to restore financial stability in Greece at the lowest cost and the least distortion to the country’s economy.
The principal obstacles to negotiating a mutually beneficial agreement appear to be political and bureaucratic. They are too arcane to go into detail on them here, but I would hope that Europe can find a way around these constraints in order to follow the most economically sensible path.
Again, let me stress that I am not endorsing a specific proposal. But, the general idea seems very much worth exploring to see if it can work for all sides.