Despite a mundane EU summit, plenty of challenges remain in Greece

Just a quick post on the developments at what must be seen as the most mundane (if not pointless) EU summit on eurozone issues for some time. Reports today suggest that the eurozone will withhold part of the bailout funds for Greece, only paying out the part required to ensure that the voluntary Greek restructuring can go ahead.

This was mostly expected and as we have noted previously, as well as in our report released yesterday, the amount that needs to be paid out is sizeable. The eurozone estimates it at €58.5bn, while we have suggested it could be closer to €86bn.

The main reason for this difference arises from the expected level of recapitalisation for Greek banks. The eurozone returns to previous estimates of around €23bn to aid the banks, despite widespread reports that this could reach €40bn - €50bn as admitted by the leaked EU/IMF/ECB debt sustainability analysis. For our part, we estimate that the bank capital needs could fall between €36bn - €46bn (depending on how they incorporated the write downs onto their balance sheets) to meet the European Banking Authority’s 9% capital requirements.

It is likely that Greek banks will need at least €50bn in the longer term, so it may be that the eurozone is keen to limit the immediate capital pay-out to the minimum necessary to stabilise the banks. This may be prudent on one hand, since it reduces the amount which needs to be raised to push the restructuring through and is less politically divisive. However, running the banks so close to the edge in an economy as uncertain as Greece’s could be asking for trouble.

The final point worth considering on the Greek banks is the issue of collective action clauses (CACs – see here for background). It looks increasingly likely that they will need to be used to get the necessary participation in the Greek restructuring (notice at this point we finally drop the ‘voluntary’ qualifier, as in no way could that still be claimed to be the case). This would leave Greek banks in a tricky situation. Under this scenario the rating agencies would likely leave Greece in a ‘default’ rating longer than expected, meaning that Greek banks will be locked out of borrowing from the ECB for some time (funds which they need to survive). The main way to keep Greek banks alive would be to transfer their funding to the Greek Central Banks Emergency Liquidity Assistance (ELA) as we discussed here.

This is far from ideal, since the ELA is opaque and secretive, but ultimately it may be necessary and unavoidable. Triggering CACs at this stage may be one of the few ways to actually deliver the debt relief which Greece needs. It presents many challenges and unknowns but it still seems better than pursuing a path which seems to be fundamentally flawed.