Submitted by George Kinits of Alcimos
First of all, the facts. According to Ms. Danièle Nouy, head of the Single Supervisory Mechanism, Greek banks were proclaimed as recently as 7 June "to be solvent and liquid". Ms. Nouy went on to say that “[t]he Greek supervisors have done good work over the past years in order to recapitalise and restructure the financial sector. That was also visible in the outcome of our stress test. The Greek institutions have experienced difficult phases in the past. But they have never before been so well prepared for them”. When pressed about the DTA/DTC issue facing Greek banks (DTA make up more than 40% of their capital), she seemed unperturbed: "That is not only a Greek issue but a general problem.[…] [W]e are now in a transitional phase, in which new capital rules are being introduced. When this has been completed, part of this problem will be fixed. But that requires a global approach”. Ms. Nouy’s view accords with the results of the ECB AQR back in October.
If you were a shareholder of a Greek bank, you wouldn’t lose sleep over your relationship with your regulator. In that context, the statement of the 12 July Euro Summit may have come as a shock—particularly the bit about the new program for Greece having to include "the establishment of a buffer of EUR 10 to 25bn for the banking sector in order to address potential bank recapitalisation needs and resolution costs, of which EUR 10bn would be made available immediately in a segregated account at the ESM". And further down: "The ECB/SSM will conduct a comprehensive assessment after the summer. The overall buffer will cater for possible capital shortfalls following the comprehensive assessment after the legal framework is applied".
You could be forgiven for thinking—where did that come from? A keen observer might also notice that one of the six things that the Summit asked Greece to do by 22 July is to transpose the Bank Recovery and Resolution Directive (BRRD). Why all the haste, then? After all, when the European Commission requested on 28 May eleven countries to implement BRRD, Greece was not even among those countries. Could the tight deadline then have anything to do with the following mention in the Summit statement: "EUR 10bn [of the buffer for the banking sector] would be made available immediately in a segregated account at the ESM"?
Let us first look at what the IMF has to say about the issue. In the IMF’s initial debt sustainability analysis of 26 June, bank recap needs were estimated at only €5.9bn (p. 7, table 1). Not the case in its latest debt sustainability analysis (14 July):"The preliminary (mutually agreed) assessment of the three institutions is that total financing need through end-2018 will increase to Euro 85 billion, or some Euro 25 billion above what was projected in the IMF’s published DSA only two weeks ago, largely on account of the estimated need for a larger banking sector backstop for Euro 25 billion [emphasis ours]".
Now let’s see what the European Commission said in its assessment of Greece’s request for support from the ESM (dated 10 July): "[S]ince end-2014, the situation of the banking sector has deteriorated dramatically amid increased State financing risks, strong deposit outflows, a worsened macroeconomic development and more recently due to the implementation of administrative measures designed to stabilise the funding situation of banks and preserve financial stability. […] The estimated size of the required capital backstop amounts on a preliminary basis to EUR 25 bn”.
Quite weird, no? Despite the fact that "since end-2014, the situation of the banking sector has deteriorated dramatically", the three institutions thought till 7 June that Greek banks were solvent and as recently as 26 June (the date of the IMF’s initial deb sustainability analysis) that only €5.9bn would be needed for bank recap. On 10 July the European Commission already thought that €25bn were needed, but that probably did not get communicated to participants in the Euro Summit on 12 July who spoke of a buffer between €10bn and €25bn (quite a broad range, that one), of which €10bn was needed "immediately". Finally, on 14 July the IMF confirmed needs to be €25bn. Quite a mess, frankly.
Now, there are two ways in which one could interpret this. Someone leery of the European institutions might think that Eurocrats came up with yet another way of enriching large European banks at the expense of the Greek and European taxpayer (some people, like former Bundesbank head Karl Otto Pöhl, claim that even the first Greek bailout was "about protecting German banks, but especially the French banks, from debt write offs"). That the €25bn will be used to endow Greek banks, which will be bailed in and then sold off in a matter of months by the Single Resolution Mechanism (SRM) (to be launched on 1 January 2016). No prizes for guessing who will buy Greek banks. Some cynics might even say that, when €25bn of public money becomes available, a bureaucrat is sure to find a way to line his friends’ pockets.
Judging from press reports, Greek bankers remain unruffled. They seem to think that the bank recap will take the form of the 2013 exercise: back then, private investors put up just 10% of the funds needed, while the rest came from the European taxpayers (via the Greek taxpayer). They seem to rely on an exception in to the general rule of the BRRD ("no public funds to be used without a bail-in"): according to point (e) of Article 59 (3) of the BRRD, "an injection of own funds or purchase of capital instruments at prices and on terms that do not confer an advantage upon the institution" does not necessitate a bail-in, as long as the supported institution was solvent (or words to that effect) at the time of the intervention.
According to this narrative, none of the three institutions had an inkling as to what exactly was happening with Greek banks—their regulator, the SSM, even thought they were well capitalized. It apparently dawned on the three institutions right around the European Summit that there was a problem, but, although they knew before the Summit that the hole was €25bn, they apparently forgot to tell Europe’s leaders how big it was, and they mistakenly thought they could fix it with perhaps €10bn. But they knew that fixing the problem is something that should happen "immediately".
That this presents a reversal of the longstanding sweep-under-the-carpet, kick-the-can-further approach of Eurocrats to all-things-Greek should not be a cause for concern. Nor should the timing raise any eyebrows: slapping an additional almost 10% of GDP onto Greece’s funding needs at a time when the Europeans and the IMF are at odds over the sustainability of Greek debt may seem a bit odd, but one should not read anything into it.
Oh, and that paragraph in the latest IMF debt sustainability analysis: "[T]he proposed additional injection of large-scale support for the banking system would be the third such publicly funded rescue in the last 5 years. Further capital injections could be needed in the future, absent a radical solution to the governance issues that are at the root of the problems of the Greek banking system [emphasis ours]. There are at this stage no concrete plans in this regard". Nothing to be concerned about, just some mandarin venting frustration.
The SSM will simply run a stress test on Greek banks, and identify a €25bn capital shortfall (despite the words of Ms. Nouy just a bit over a month ago). Greek banks will be able to complete their capital raising exercises by 31 December 2015 (when, according to Article 32(4) of the BRRD the only exception to "no public funds without a bail-in" rule expires); if not, the always obliging European Commission will certainly provide an extension. Investors will certainly flock to subscribe for Greek bank rights issues, despite having thrown €8.3bn down the drain by doing the exact same thing just over a year ago.
Of course, there are some rather inconvenient facts, which one would need to ignore under this scenario: for example, if the SSM has to run stress tests on Greek banks, this will take some time. Why then the rush to implement BRRD and the need to set aside the €10bn for Greek bank recap "immediately"? Oh, and there is that Bruegel report on Greek bank recap which came out while the Euro Summit was still in progress, and puts things rather bluntly: "[T]he potential package for Greece would include 10 to 25bn for the banking sector in order to address potential recapitalisation needs. Rumours this morning suggest the banks would then become part of a new asset fund and sold off to pay down debt" (mind you that the piece was already published at 7am). Again, nothing to worry about, just some academic hokum.
And if you believe all that, there's a bridge in Brooklyn I want to sell you.