March 4, 2021

News Analysis: Propping Up Banks, as Well as Greece

FRANKFURT — Europe’s latest plan to prop up Greece seems, on closer examination, to look suspiciously like a plan to bolster European banks.

By agreeing to contribute a relatively modest amount to the rescue, the banking industry is getting something more valuable in return, analysts say. The industry is unloading much of its Greek risk onto the European Union and helping to quash fears that the sovereign debt crisis could morph into a second financial crisis.

The agreement reached in Brussels last week may anger anyone who thinks that banks have already gotten enough taxpayer favors. But the European sovereign debt crisis has always been as much about banks as it has been about Greece. If the deal helps restore confidence, weaker institutions would be able to borrow on money markets again, so they no longer would be dependent on the European Central Bank for financing.

“I think this is a good use of resources,” said Carl B. Weinberg, chief economist at High Frequency Economics in Valhalla, New York. “This prevents the hit from becoming so large that it paralyzes the banking system.”

The irony, of course, is that Chancellor Angela Merkel of Germany went to Brussels last week vowing to make banks pay their share of the cost of aiding Greece. She inadvertently seems to have done them a favor instead.

The plan agreed to by Ms. Merkel and other leaders calls for banks to voluntarily swap some of their Greek bonds for more solid paper backed by collateral. Though the swap is technically voluntary, Moody’s Investors Service warned Monday that such action would be considered a default by Greece. Moody’s also downgraded Greece another three notches to just one level above a default grade.

But Moody’s also said that the plan would benefit Europe “by containing the contagion risk that would likely have followed a disorderly payment default on existing Greek debt.”

The debt swap endorsed by European leaders last Thursday will cost banks and other investors €54 billion, or nearly $78 billion, according to estimates by the Institute of International Finance, the industry group that represented banks and insurance companies in negotiations with European governments.

That sounds like a lot of money, but as Mr. Weinberg pointed out, a week ago banks were staring at the possibility that Greece would slide into a disorderly default, with losses in the range of €200 billion, not to mention untold collateral damage.

“Compared to a €200 billion hit, this looks to me like a really good deal,” Mr. Weinberg said. In any case, he said, the cost to banks could turn out to be much lower than €54 billion.

Financial institutions still have substantial exposure to Greece, said Charles H. Dallara, managing director of the Institute of International Finance, who played a key role in the negotiations. The organization estimates that private-sector bond investors still have €200 billion at risk in the form of future interest payments by Greece. In addition, only about one-third of the new paper that Greece creditors will get is backed by collateral, Mr. Dallara said.

Still, he agreed that the deal will help Greece’s problems from infecting banks.

“This has really injected a new stability into the European financial landscape which had certainly been lacking in the past week,” Mr. Dallara said by telephone. He noted that the Brussels agreement came only a week after European regulators had compelled banks to detail their exposure to Greek bonds, an event which also helped clear up doubts about where the risk was buried.

European bank shares rallied late last week as investors appeared to agree that institutions emerged stronger from the Brussels talks. Bank shares fell Monday, but the decline seemed to be driven more by worries about political deadlock in the U.S. budget process than about Europe.

A key test will come on Tuesday when the European Central Bank discloses demand for one-week loans from banks in the euro zone. The amount spiked last week, a sign that many banks were having trouble borrowing money from other banks.

If demand falls Tuesday and in coming weeks, it would be a sign that tensions are easing.

“Banks are suspicious of each other because they don’t know who is holding the bag,” Mr. Weinberg said.

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