Greece: Selected Issues and Statistical Appendix

This paper provides model-based projections of inflation, and quantifies the impact of the factors that determine inflation. The reasons behind the poor labor market performance in Greece and the remedial policies are discussed. The new economy is at a relatively early stage of development in Greece compared with most industrial countries, but growing rapidly. The key issues facing the Greek banking sector, against the background of its recent performance and a rapidly evolving market and regulatory environment, is discussed. The statistical data are also presented.

Abstract

This paper provides model-based projections of inflation, and quantifies the impact of the factors that determine inflation. The reasons behind the poor labor market performance in Greece and the remedial policies are discussed. The new economy is at a relatively early stage of development in Greece compared with most industrial countries, but growing rapidly. The key issues facing the Greek banking sector, against the background of its recent performance and a rapidly evolving market and regulatory environment, is discussed. The statistical data are also presented.

V. The Greek Banking Sector at the Time of EMU Entry: Recent Developments and Challenges Ahead67

A. Introduction

136. This chapter examines the key issues facing the Greek banking sector, against the background of its recent performance and a rapidly evolving market and regulatory environment. The chapter builds on earlier Fund staff work on the financial sector in Greece and focuses in particular on recent developments, and on opportunities and challenges emanating from monetary union.68

137. The Greek banking system is in the process of far-reaching restructuring. During the 1980s, the system was heavily regulated and was primarily serving an inefficient public sector. Interest rates for nonpreferential private sector borrowing were high, which kept private investment at a relatively low level and retarded private sector development. This changed after the deregulation and liberalization of the banking sector in the 1990s, which freed bank lending from many layers of state interference, revitalizing competition, flexibility, and efficiency. Greek banks have been lending increasingly to the private sector, with consumer lending one of the fastest growing sectors in recent years. The narrowing of spreads and growing competition from nonbank financial institutions have pushed banks to look for alternative revenue sources to help boost their noninterest income. Consolidation and privatization have created larger and more cost-conscious financial groups. Profitability has increased and banks have expanded into new financial services. Furthermore, supervision has improved and prudential regulation has been strengthened according to EU directives.

138. However, as this chapter reports, the Greek banking system faces evolving challenges, particularly after Greece’s EMU entry in January 2001. Despite recent privatization, the state still controls, directly or indirectly, a large part of the banking system. Even though the financial strength of the Greek banking sector improved after liberalization, it is still below that of other EU countries. Bank capitalization increased markedly in recent years and almost all Greek banks fulfill the 8 percent minimum capital adequacy ratio, but the ratio of nonperforming loans (NPLs) is relatively high, despite rapid improvement since the mid-1990s. Furthermore, provisioning for nonperforming loans is relatively low, despite its growth in recent years. Bank profitability has improved in recent years, but partly because of temporary events (capital gains from stock and bond holdings). Furthermore, Greek banks have not been very successful in reducing costs and are still lagging behind other EU countries, particularly in controlling personnel expenses.

139. This chapter concludes that to reach best industry practices, Greek banks have to further strengthen performance, and improve risk management and internal control practices. Room remains for further progress in reducing operating costs and the still high NPL ratios, and it is important to increase provisioning for nonperforming loans. Supervisors also face new challenges in a liberalized and rapidly changing banking sector, with evolving financial services—at a time when credit growth rates are already high. The Greek banking sector is generally considered to be well prepared to deal with these challenges, and most performance indicators have strengthened in recent years. However, strong reliance on high interest margins in the past and rising competition, particularly after Greece’s entry into the euro area, heighten the urgency for Greek banks to further strengthen their performance.

140. The rest of the chapter is structured as follows: Section B compares the banking system before and after liberalization and discusses the recent consolidation and privatization process and how it has changed the structure of the banking system in Greece; Section C briefly discusses recent credit market developments in the Greek economy; Section D examines the present health and recent performance of Greek banks; Section E highlights the main elements of the new regulatory and supervisory framework of the Greek banking system and the EU directives it is based on; and Section F concludes.

B. The Banking Sector in Greece Before and After Liberalization

141. Before the beginning of liberalization in 1987, the banking sector in Greece was heavily regulated and state interference in its business was the norm. Bank credit was often used to finance large fiscal deficits, and to provide loans to state enterprises and to sectors that the government considered of national interest. Commercial banks were required to invest three-fourths of their deposits to finance preferential activities, a large part of which had to be placed in treasury bills (40 percent of their deposits).69 The sector was subject to strict branching regulations, asset holding restrictions, and legal barriers to developing new financial products. The National Bank of Greece and the Commercial Bank, both large state-owned banks, dominated the banking sector. The management of state banks was appointed by the government and changed frequently, while the hiring of new staff burgeoned before elections. Provisioning for loan losses was low compared with international standards, primarily because the government used to guarantee a big portion of the loans granted by state banks, and tax deductions by banks for provisions could not exceed 1 percent of average loans outstanding each year.

142. These strict regulations had created a rigid banking system and distorted market incentives. Banks could not maximize profits, and because of limited competition, they did not have to be cost conscious or to adopt advanced technologies. Loans to specific sectors and to state enterprises had very low or even negative real interest rates, while non-preferential borrowers paid much higher rates. The interest rate spread for private sector loans was among the highest in the OECD countries, fluctuating within a range of 9–12 percent, while depositors were earning negative real interest rates.70 Strict foreign exchange controls resulted in a large black market for foreign exchange.

143. The far-reaching liberalization of the Greek banking system started in 1987 and accelerated in the 1990s.71 Interest rates on loans were liberalized in 1987, and on deposits in 1989. Rules forcing banks to invest in treasury bills and lend to state enterprises and preferential sectors were abolished in 1993. Controls on international flows of long-term capital were liberalized in 1993, and for all other capital account transactions, in 1994. Furthermore, during the 1990s, supervision improved and prudential regulation was strengthened to meet the EU directives on bank supervision (see Section E below).

144. Banks are authorized to be involved in all types of banking activities, and need no approval from the Bank of Greece for standard operations. Competition has increased and domestic banks are expanding to wholesale banking, an area serviced primarily by foreign banks in the past. Moreover, nonbank financial institutions are moving into traditional banking activities. Higher competition among banks and nonbank financial institutions has stimulated productivity and sophistication in the Greek financial system. Furthermore, liberalization has led to substantially reduced interest rate spreads, closer to the euro-area levels.72

145. Based on most available indicators, the banking sector’s performance has improved substantially since liberalization (see Table 1 and Section D). For the five largest banks, profitability (measured as net profits over total assets) more than doubled in the first half of the 1990s compared with the 1980s, while staff expenses as a percent of gross profits declined by more than 40 percent. Remarkably, profitability was higher and staff expenses lower in private banks than in banks under state control for the whole period from 1960 until the mid-1990s.

Table 1.

Greece: Historical Data for Profitability and Staff Expense Ratios of the Five Larger Greek Commercial Banks, 1960-96

(In percent)

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Source: 1960-96: Annagou (1999).

Under state control.

Private until 1974 and under state control in 1974-1996.

Private bank.

146. Privatization has facilitated consolidation in the Greek banking sector (Table 2). Consolidation and privatization in the Greek banking sector started late compared with other countries in the euro area. Consolidation was initially limited primarily to large private banks purchasing smaller state banks in an effort to increase their size and improve their domestic market position, ahead of Greece’s participation in EMU. Other driving forces behind consolidation included cost efficiency and efforts to expand clientele in new financial services. To date, the government has privatized the Bank of Central Greece, CretaBank, General Hellenic Bank, Macedonia Thrace Bank, and Ionian Bank.73 It is also gradually selling parts of its stake in larger state banks such as Commercial Bank and the Agricultural Bank of Greece.74

Table 2.

Greece: Mergers and Acquisitions in Greece in the 1990s

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Source: Bank of Greece.

147. Consolidation and privatization have created larger financial groups. Increased concentration created five such groups (in addition to the Agricultural Bank of Greece, which is the third largest bank by asset size), accounting for 95 percent of commercial bank assets in Greece in 2000, compared with 77 percent in 1998 (Table 3).75 At the end of 1999 there were 16 Greek commercial banks and 13 cooperative banks, compared with 20 and 5, respectively, four years ago (Table 4).76 According to a recent survey, 6 Greek credit institutions were among the largest 150 in Europe, based on Tier-1 capital in 1999.77

Table 3.

Greece: Market Share of Greek Commercial Banks 1/

(In percent)

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Source: National Baok of Greece.

Excluding the Agricultural Bank of Greece and the Post Office Fund.

Absorbed by Alpha Credit Bank in October of 1999.

Absorbed by Pireaus Group during the first half of 2000.

Absorbed by EFG Eurobank in October of 1999.

Absorbed by EFG Eurobank in July of 2000.

Table 4.

Greece: Bank Ownership

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Source: Bank of Greece.

148. Despite recent consolidation and privatization, state-controlled banks remain an important feature of the Greek banking system. Although the number of directly or indirectly controlled (for example, through pension funds) state commercial banks was reduced from 8 in 1995 to only 2 in 2000 (4, including the Agricultural Bank and the Post Office Fund, which are considered specialized banks), these banks are among the largest in Greece. Together, the National Bank of Greece and the Commercial Bank of Greece held roughly half of commercial bank assets, loans, and deposits in 2000. Even though most state ownership of these banks is indirect, the state has in the past appointed their management. However, the government announced recently that management in these banks would be appointed by shareholders in the future, which would substantially reduce state control in the banking sector.78

149. Large foreign financial groups have recently expressed interest in the Greek market and some have formed strategic alliances with Greek banks. At the end of 1999, 22 foreign banks operated in Greece, with almost 12 percent of total assets in the banking sector, which is a small increase from 10 percent 10 years ago (FitchIBCA (2000). So far, they have primarily specialized in asset and portfolio management, credit cards, mutual funds, derivatives, insurance, and investment banking. Greek banks can benefit from the expertise and experience of foreign banks in risk management, international markets, and new financial products and services by forming strategic alliances. Some of these alliances have created new companies specializing in specific financial services.79

C. Recent Credit Market Developments

150. With the lifting of earlier restrictions, Greek banks have shifted their lending more and more toward the private sector. They are free to design their credit allocation subject only to prudential rules by the Bank of Greece. Furthermore, fiscal tightening in recent years has significantly reduced the government’s borrowing requirements. Private sector credit growth was almost 17 percent on average in the last five years, and accelerated to almost 28 percent in September 2000, and the outstanding stock amounted to 58 percent of GDP (Table 5). According to the most recent available data (August 2000), 68 percent of private sector credit from commercial banks is short-term lending and about 34 percent is denominated in foreign currency, compared with 70 percent and 23 percent, respectively, in 1995. Foreign-currency-denominated credit grew by 23 percent in 1999 and by 32 percent in August of 2000 (most of it in U.S. dollars, yen, and euros; see Table 6), primarily to take advantage of lower interest rates before the convergence of Greek interest rates to the euro-area levels.

Table 5.

Greece: Credit to the Private Sector, 1995-2000 1/

(In bil60ns of drachmas)

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Source: Bank of Greece.

Change are during the last 12 months.

Up to September 2000 for total credit and up to August 2000 for commercial bank credit.

Table 6.

Foreign Currency Position of Greek Commercial Banks, 1996-2000

(In billions of Greek drachma)

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Source: Bank of Greece.

All data are for December 31, except for 2000, which are June 30.

151. Consumer lending, an undeveloped segment of the credit market in Greece until recently, has been one of the fastest-growing sectors. It increased by 31 percent in 1999 and almost 27 percent in August of 2000, reaching 11 percent of total commercial bank lending. The introduction of credit controls by the Bank of Greece for the period from April 1999 to March 2000 did not succeed in slowing down credit expansion.80 Credit card and auto loans are the fastest-growing consumer loan areas, albeit from very low starting positions. Other fast-growing segments of the credit market include housing, trade and industry.

152. Credit growth may accelerate further in the period ahead. Earlier euro-area entrants experienced rapid credit expansion to households and enterprises.81 Domestic credit as a percent of GDP was 75 percent in Greece in 1999, compared with 132 percent on average in the euro area. The banking sector in Greece is still small compared with the banking sectors in other EU countries. The ratio of credit institutions’ assets to GDP in Greece was about 134 percent in 1999 and is the lowest in the EU (the EU weighted average was about 244 percent).82 The reduction in reserve requirements from 12 percent to 2 percent in 2001 and the decline of interest rates to euro-area levels at the beginning of the same year should lead to more credit expansion.83

D. The Health and Recent Performance of the Banking Sector in Greece

153. The financial strength of Greek banks is considered adequate, but below that of other EU countries. According to Moody’s ratings of bank financial strength, the Greek banking sector is rated at D to D+ (D stands for adequate), which is the lowest in the EU area (Table 7). Based on individual bank ratings, 2 Greek banks have a C rating of financial strength (C stands for good), while the Agricultural Bank has a rating of E+ (E stands for very weak) and all other banks have a D or D+ rating (Table 8).

Table 7.

Average Bank Financial Strength Ratings for Selected Countries, January 2000

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Source: Moody’s Banking System Outlook.Note: B = strong, C =good, D =adequate, and E =very weak.
Table 8.

Greece: Credit Ratings of Selected Banks, January 2000

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Moody’s Banking System Outlook.

FitchIBCA.

154. Bank capitalization grew markedly in recent years (Tables 9 and 10). Almost all Greek banks fulfill the 8 percent minimum capital adequacy ratio (CAR).84 The average CAR for the Greek banking sector was 18.2 percent in 1999, a considerable increase from 12 percent in 1998, primarily because of an impressive stock market performance, as well as reflecting banks’ new share issues.85 The Tier-1 capital ratio increased in 1999 to 17.7 percent, from 12 percent in the previous year, while the equity to total assets ratio reached almost 10 percent in 1999, compared with almost 6 percent in 1998. International comparisons show that Greek banks do not seem to lag in capital adequacy. The capital-to-assets ratio in Greek commercial banks was 5.1 percent in 1997 (the latest available cross-country comparison), which was higher than that in Germany, the Netherlands, and the United Kingdom, but lower than in Portugal and Spain (Table 11).86

Table 9.

Greece: Commercial Banks Balance Sheet, 1992-1999

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Source: Bank of Greece.
Table 10.

Greece: Commercial Banks Income Statement, 1992-2000

(In percent of average total assets)

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Source: Bank of Greece for 1992-99. National Bank of Greece for 2000.

June 2000

The: nonperforming loans ratio in 1999 was 10.7 percent exculding the Agricultural Bank of Greece.

Only for the six largest Greek banks.

Liquid assets are defined as cash and balance with the Central Bank plus interbank deposits plus treasury bills.

Defined as tier 1 capital over risk-weighted assets.

Table 11.

Commercial Banks in Greece and Selected European Countries, 1997

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Source: OECD, (1999).

All banks.

155. However, the Greek banking sector still has a high ratio of nonperforming loans, despite improvements since the mid-1990s. The ratio of nonperforming loans to total loans (NPL ratio) actually increased in 1999, reaching 14.7 percent, compared with 13.6 percent in 1998.87,88 Even though this is an improvement compared with a ratio of 19 percent in 1996, it is still relatively high; for example, the NPL ratio in Portugal was 3 percent in 1999 (International Monetary Fund, 2000). To some extent, this reflects the situation at the Agricultural Bank, which is in the process of cleaning up its portfolio. However, even excluding the Agricultural Bank, the NPL ratio was still 10.7 percent in 1999, and thus relatively high by international standards.89

156. Provisioning for NPLs has improved in recent years, but is still low compared with other industrial countries. Provisioning in the six largest Greek commercial banks was almost 4 percent of total loans in 1999, or 27 percent of NPLs, compared with more than 3 percent and almost 17 percent in 1996, respectively. This is considerably lower than in other EU countries (for example, provisioning over nonperforming loans are more than 100 in Portugal). Capital adequacy is considerably lower when the large number of NPLs not covered by provisions is taken into account. Subtracting these NPLs not covered by provisions from equity brings the equity/total assets ratio for the 6 largest Greek banks to 5.6 percent from 10.1 percent in 1999. However, this is a considerable improvement from 1.8 percent in 1998, or from negative ratios in earlier years.90

157. The reasons for the high NPL ratio in Greece are partly related to the way the sector was organized before its relatively recent reform. Government interference in lending policies during the 1980s, requiring lending to specific sectors and to frequently troubled state companies, resulted in a large number of bad loans. In addition, inadequate procedures for monitoring troubled loans and overreliance on borrowers’ collateral rather than cash flows to approve loans harmed the banks’ portfolios.

158. Greek banks are in the process of significantly upgrading their risk management and credit approval systems and procedures, following the Bank of Greece’s new rules. The recent deregulation and liberalization of the banking sector, higher competition at the domestic and European levels, and new sophisticated financial instruments make it essential for banks to employ advanced risk management systems. The Bank of Greece, following EU directives, introduced in 1998 requirements for all commercial banks to set up an internal control system, an audit committee, and an internal supervision unit for credit risk management, which will report directly to management. Greek banks are currently implementing these requirements. Furthermore, large banks have started implementing value-at-risk models.

159. Bank profitability improved markedly in 1999. For the commercial banking sector, average net income before provisions more than doubled as a share of average assets, to almost 4 percent. Return on assets (ROA) exceeded 3 percent, compared with 1.2 percent in the previous year, and return on equity (ROE) increased to 37 percent from 22 percent during the same period. Data for individual commercial banks show that almost all banks experienced a sizable improvement in their profitability in 1999 (Table 12). Cross-country comparisons of bank profitability in 1997 show that the ratio of net income over total assets of the Greek banking sector was comparable to that of other European countries.

Table 12.

Greece: Profitability Ratios of Greek Commercial Banks

(In Percent)

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Source: National Bank Greece.

Absorbed by Alpha Credit Bank in October of 1999.

Absorbed by Pireaus Group during the first half of 2000.

Absorbed by EFG Eurobonk in October of 1999.

Absorbed by EFG Eurobank in July 0f 2000.

160. However, the improvement in bank profitability in 1999 stemmed partly from temporary events that are unlikely to be repeated in the future. Banks’ holdings of stocks delivered large capital gains in 1999, after the impressive performance of the Greek stock market during that year. Net profit from financial operations more than tripled in 1999. Significant capital gains were also realized from government bond holdings, as interest rates declined to converge to the EMU interest rates.91 The temporary nature of some of the 1999 profits was illustrated by more recent developments. In 2000, the stock market experienced a sharp correction.92 And while capital gains from bond holdings continued during 2000, they had largely ended by 2001, with the convergence of Greek to euro-area interest rates.

161. Reflecting the waning of some of the temporary factors, bank profitability declined in the first half of 2000—although it was still higher than in 1998. The average ROA of the Greek commercial banks declined to 2 percent in the first half of 2000, while the average ROE declined to 23 percent in the same period. All the commercial banks in Greece experienced a decline in profitability by mid-2000. After the adoption of the euro, revenues from foreign exchange transactions will decline, although the elimination of the exchange rate risk vis-à-vis the euro-area countries is expected to reduce hedging costs.

162. The narrowing of spreads and increasing competition from nonbank financial institutions have pushed banks to look for alternative revenue sources. Interest income as a share of average assets declined from more than 12 percent in the first half of the 1990s to 9 percent in 1999. This decline is not large, given the recent fall in interest rates, because of fast credit growth in recent years, including credit for segments with relatively high interest rates (e.g., consumer loans). Noninterest income, such as from trading and commissions, increased to 3 percent of average assets in 1999, and despite a decline to 2.3 percent during the first half of 2000, it remains higher than in earlier years (Table 13). High demand for consumer loans and the introduction of new financial products has helped banks to diversify their revenue sources. Nonbank financial institutions—such as mutual funds, pension funds, and insurance companies—are capturing a growing share of the market, and as a response, banks have been trying to enter new areas of financial services. For example, investment in mutual funds increased from about 9 percent of GDP in 1995, to 26 percent in 2000. Their number reached 233 mutual funds in 2000, compared with only 40 just two years before, managed by 31 companies, most of them banks.93 Most banks are now offering a wide range of financial products and services, such as asset and portfolio management, credit cards, mutual funds, derivatives, insurance, and investment banking.94 Banks have also started expanding their expertise in brokerage services, security underwriting, and mergers and acquisitions.

Table 13.

Greece: Income Analysis of Greek Commercial Bank, 1998-2000

(In percent)

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Source: National Bank of Greece.

Absorbed by Alpha Credit Bank in October of l999.

Absorbed by Pireaus Group during the first half of 2000.

Absorbed by EFG Eurobank in October of 1999.

Absorbed by EFG Eurobank in July of 2000.

163. Despite recent efforts, Greek banks have not been very successful in reducing costs and are still lagging behind other EU countries. This raises concerns, particularly because the recent increase in bank profitability may reflect temporary factors, as discussed, and bank competition is expected to intensify in the future. Based on comparisons for 1997, the operating expense ratio in Greece was among the highest in the EU. Recent efforts to cut expenditures have not resulted in a break from the past, and the ratio of operating expenses to average assets actually rose in 1999 (although preliminary estimates show a small decline in 2000; Table 14).

164. Personal expenses are particularly high relative to such expenses in other EU countries. The number of bank employees per branch was 23 in 1999, compared with the EU average of 20, but has been declining (it was 32 in 1992). High personnel costs reflect in part relatively rigid Greek labor regulations (see also Chapter III), which has been the main obstacle to cutting employment, particularly in state banks, which have a higher number of bank employees per branch than private banks.

Table 14.

Greece: Cost Analysis of Greek Commercial Banks, 1998-2000

(In percent)

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Source: National Bank of Greece.

Abrorbed by Alpha Credit Bank in October of 1999.

Aborbed by Pireaus Group during the first half of 2000.

Aborbed by EFG Eurobank in October of 1999.

Ablorbed by EFG Eurobank in July of 2000

E. The Regulatory and Supervisory Framework of the Greek Banking System

165. Three main institutions supervise the financial system in Greece, with some coordination in overlapping areas of responsibility. The Bank of Greece supervises credit institutions; the Capital Markets Committee (CMC) supervises investment banking, fund management, securities, and brokerag