Bruegel: Preserving the Greek financial sector - options for recap and assistance

13 July 2015

Could the ESM play a productive role in a likely rescue of Greece’s embattled banking sector?

In short:

·       Regaining the stability of the Greek financial sector is key, as a meltdown could lead to Grexit. The stability of the Greek financial system currently relies on the provision of ECB liquidity, which in turn is only available to solvent banks.

·       While Greek banks were found to be solvent and well capitalised in the AQR, the deterioration of the economic situation over these months has been such that this assumption may now be questionable. The quality of capital is also put at risk by the heavy reliance of Greek banks on Deferred Tax Assets instruments.

·       The draft text discussed in the Eurogroup yesterday suggests that the 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. Recapitalisation can be done in different ways, with different consequences. Here, I compare four possible scenarios to recapitalise the Greek banks.

·       Europe disposes of an instrument to recapitalise the Greek banks limiting impact on the Greek debt, while at the same time awarding the ESM more control on the banking system. This instrument is the ESM tool for direct recapitalization, born with the initial aim to break the sovereign-bank vicious cycle and never used as of today.

·       The back of the envelope calculations included here will show that the problem with the instrument as it currently stands is that it would require, before the ESM can step in, a very significant bail-in of 8% of total liabilities. Given e structure of Greek banks’ liabilities, meeting this requirement would need a 100% haircut on junior and senior (non-government-guarantee) bonds plus very high haircut on uninsured deposits (up to 39% in one bank).

·       On the basis of the exercise performed here, the best solution to recapitalize the Greek banks would be to make use of the ESM direct recap but in a way that allows it to make an actual difference, i.e. limiting bail-in to what is currently mandatory under the amended State aid requirement.

Full article on Bruegel

CEPS: Restructuring the Greek banking sector with an empty purse


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