The good, the bad and the foreign: Icelandic lesson for stabilising the Greek banks*

Ever since 2010, when Greece first turned to the IMF for assistance, the crisis handling has been characterised by too little too late, which is why Greece is still grabbing the headlines. The Greek banks are a serious part of the problem with liquidity crunch and non-performing loans at 33.5% 2010-2014 according to World Bank data. Banks with such numbers can hardly perform their role of stimulating the economy with sustainable lending. Whatever measures Greece will use to tackle its problems the banks have to be dealt with.

In October 2008 the three largest banks in Iceland experienced liquidity problems due to a series of mistakes, fickle foreign funding, outright fraud, bad luck and a weak lender of last resort.

The Greek banks are in a less dire situation than their Icelandic counterparts in 2008. However, if Athens, Brussels and Frankfurt do not soon present a credible plan for Greece a bank run (compared to the recent trot of €100-200m a day) unavoidably ensues at some point: depositors, distrusting the deposit insurance system, take out their savings and stash them at home rather than waiting for a bail-in, as in Cyprus or bankruptcy proceedings.

Here is a lesson from Iceland. In October 2008 the Icelandic government acted on a bank run by forcing the dysfunctional banks, by then lacking liquidity, into receivership, splitting their operation in two. Instead of the classic split into a good bank/bad bank the domestic operations were consolidated in a New bank with the foreign operations left in the estate of the Old failed bank; in effect a split into a good domestic bank and a bad foreign one. Some weeks later, capital controls were put in place, forcing investors to stay put and shoulder the risk.

An aside on the Icelandic capital controls: they came into being with full support of the International Monetary Fund, IMF because the foreign currency reserves were not enough to meet demand. This is a very different situation from Cyprus where capital controls were put in place for the banks to hold on to deposits, as would be the case if capital controls were used in Greece.

The Greek banks do now rely on both domestic and foreign funding: domestic deposits and European Central Bank, ECB, funds (through various mechanisms) amounting to 20-25% of the balance sheet.  The assets are mostly domestic: performing and non-performing loans, cash, real estate etc. Hence, a clean domestic/foreign split is not possible – but a mixed split is.

Table 1 gives an example of the balance sheet of a typical Greek bank and what a domestic and semi-foreign split might look like:

Billion Euros “Old” banks “New” Bank “Bad” bank
Total assets 172 120 52
Loans to customers 144 104 40
Cash 6 6
Other (Equipment) 22 10 12
Total liabilities 158 110 48
Deposits 110 110
ECB funding 40 40
Other 8 8
Equity (including funds from HSF) 14
Greek gov equity 10

A split would wipe out most of the assets owned by the Hellenic Financial Stability Fund (or indirectly the European Financial Stability Facility) amounting to €17bn or 7% of GDP. The Greek government would have to put in equity, at least 8% of the balance sheet of the new bank in accordance with Basel rules. Performing loans would be moved to the New/good bank with non-performing loans left in the Old/bad bank.

Hence, the split would be a mixture of good bank/bad bank and a domestic/foreign. The ECB would unavoidably be left with non-performing Greek loans locked inside a bankrupted estate in exchange for its involvement in recent years. As in Cyprus, some form of temporary capital controls might be needed.

This strategy is of course no panacea but it could be an important step towards stabilising and stimulating the economy. It is indeed costly for all involved parties; in an estate the ECB Emergency Liquidity Assistance, ELA, the provision now being €68.3bn, would automatically be discounted and the ECB treated equal to other creditors. However, instead of the perennial too little too late the cost of stabilising the Greek banking system once and for all might well be worth a whole lot to the Eurozone.

*This article was co-written with Thórólfur Matthíasson professor of economics, University of Iceland. A French version of this article has appeared on the website of Le Monde ($$$). In 2013 we wrote Five years on: Myths and lessons from post-collapse Iceland – and the Eurozone debt crisis seen from the North; see also our article on the cost of the Icelandic banking collapse: State Costs of the 2008 Icelandic Financial Collapse.

14 thoughts on “The good, the bad and the foreign: Icelandic lesson for stabilising the Greek banks*

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