Greece (2008) – Capital Injections

On October 15, 2008, the Greek government announced a €28 billion ($36 billion) package estimated at 11.4% of GDP. The Greek package included three pillars: bank recapitalizations (€5 billion), guarantees on debt issuance by banks (€15 billion), and liquidity support via special government bonds (€8 billion) (EC 2008a; Greece 2008a; Mayer Brown 2009; Reuters 2008). The recapitalization scheme was not aimed at distressed banks. It was aimed at strengthening capital ratios against possible losses (EC 2008a).

Greek Law 3723/2008, “Enhancement of Liquidity in the Economy in Response to the Impact of the International Financial Crisis,” went into effect on October 24, 2008, less than two weeks from its announcement. However, the Greek authorities committed that the law would not be applied before the European Commission’s approval (EC 2008a). The Bank of Greece contributed significantly in the drafting of the law. It provided technical support and recommendations on the financial support to banks, based on capital adequacy and liquidity needs (BoG 2014).

On November 19, 2008, the EC authorized the Greek package under EU State Aid rules compatible with Article 87 (3)(b) of the EC Treaty that permits the use of State Aid to “remedy a serious disturbance in the economy of a Member State” (EC 2008a).

On October 12, 2008, in a summit held in Paris, euro area heads of state released the “Declaration on a Concerted European Action Plan of the Euro Area Countries,” which committed efforts to reestablish confidence and the well-functioning of the financial system. European governments, central banks, and supervisors agreed to support financial institutions by facilitating: (a) appropriate liquidity conditions, (b) funding of banks, (c) additional capital resources, (d) recapitalizations of distressed banks, (e) flexibility in the implementation of accounting rules, and (f) cooperation among European countries (Euro Summit 2008).

The Supervisory Council was set up by Greek law and was chaired by the Greek minister of economy and finance with the participation of the BoG governor, the deputy minister of economy and finance, and the Greek state’s representatives at the boards of directors of the participating banks. The Council convened monthly to coordinate the implementation of the law and make sure depositors, borrowers, and the Greek economy benefited from the scheme (EC 2008a).

The EU State Aid was intended to be limited in time and scope. The Greek government could acquire up to €5 billion in preferred shares in banks that chose to participate in the recapitalization scheme (EC 2008a).

Eligible institutions included all banks authorized to operate in Greece with license from the BoG, including subsidiaries of foreign banks. Banks could increase their capital by issuing preferred shares regardless of whether their transferable securities were listed in organized markets or the stock exchange (EC 2008a).

Initially, in 2008, Greek banks were reluctant to participate in recapitalizations due to potential negative market reactions (stigma effect), concerned that their subscription could indicate weakness (BoG 2014). A representative from the BoG pointed out that given the magnitude of the financial crisis seen by the end of 2008, and the trends and expectations of a prolonged period of financial turmoil and deteriorating asset quality, over a period of time, the BoG informally persuaded Greek banks to participate in recapitalizations.

Banks willing to participate in the recapitalization scheme had to communicate their interest by February 1, 2009. Then, they had to issue the preferred shares by May 19, 2009 (six months after the approval of the scheme). The window to issue the preferred shares could be extended up to December 31, 2009, upon the European Commission’s approval (EC 2008a).

Bank recapitalizations were accepted based on supervisory criteria. First, the amount of capital required to meet the capital adequacy level of a Tier 1 ratio between 8% and 10%, as defined by the BoG, was weighted at 50% of the total evaluation. Second, the size of the bank, its market share, and its importance in preserving financial stability was weighted at 40%. And third, the contribution of the bank in financing small and medium-sized enterprises and residential loans was weighted at 10% (EC 2008a).

The amount to purchase was decided by the minister of economy and finance, based on the recommendation of the governor of the BoG (EC 2008a). The Greek government issued Greek government bonds paying interest set at a spread to Euribor to cover the price of the preferred shares, which was determined as the nominal value of common shares of the bank’s most recent issuance (Greece 2008a).

In the case of the Proton Bank Group, after the 2009 recapitalization of €80 million, its balance sheet increased from €1.9 billion in 2008 to €2.9 billion in 2009, and to €4.3 billion in 2010. Thus, its balance sheet grew by more than 100% from 2008 to 2010 (EC 2012a). In 2011, the BoG withdrew the license of Proton bank and placed the entity in liquidation (BoG 2011).

In the recapitalizations, the Greek government acquired exclusively preferred shares as they were considered Tier 1 capital by the BoG. Through the recapitalizations, banks reached a Tier 1 capital ratio of 8% or above, which had to be maintained throughout the duration of the scheme. The capital adequacy ratios set by the BoG also corresponded with 8% of Tier 1 capital (EC 2008a).

The preferred shares paid a 10% dividend. They were noncumulative and considered noncore Tier 1 capital. Based on EU State Aid rules, recapitalizations had to be performed at terms that minimized the amount of aid. Data at the time, under distressed market conditions, showed that the yield for hybrid Tier 1 capital, such as preferred shares, was around 15% or more. However, the European Commission recognized that setting a higher dividend yield, in the vicinity of that market level, would discourage banks from participating in the recapitalizations. Additionally, the EC intended to adjust to long-term market conditions and not to impose unfavorable conditions at the time. The EC noted in approving the Greek program that in the UK and Germany, the programs had come with strict behavioral conditions and paid dividend yields of 12% and 10%, respectively. Consequently, the commission positively observed that if equivalent behavioral conditions were met, the 10% yield in the Greek case was appropriate and reflected a market-oriented remuneration on the capital injected. In the case of a bank’s liquidation, preferred shares held priority over common shares (EC 2008a).

For recapitalized banks that did not repurchase the shares after six months, Greek authorities committed to notify the Commission of restructuring plans submitted by the participating banks (EC 2009). Cases of conversions of preferred shares into common shares were also considered within the restructuring plan (EC 2008a).

The commission noted that the restructuring plans were the foundation of the Community Guidelines on State Aid for Rescuing and Restructuring Firms in Difficulty for the commission’s understanding of EC Article 87 (3)(c) for aid of this kind. It was important that banks returned to long-term viability and the plans were adequately scrutinized. The EC did not require restructuring plans for banks that repurchased the preferred shares within six months (EC 2008a). Additionally, if further recapitalizations were needed, Greek authorities ensured that future beneficiary banks were fundamentally sound, which they scrutinized ex ante, and provided this information to the commission at the time of a capital injection. Greek authorities notified the European Commission of a restructuring plan within six months of the capital injection. If the Greek government intended to recapitalize a bank previously recapitalized, then Greek authorities had to present an individual notification for the commission’s approval (EC 2008a).

The Greek state, through the preferred shares acquired, was allowed to appoint a representative in a bank’s board of directors. The state representative attended the bank’s general assembly of common shareholders and had veto power on decisions related to dividends distribution as well as benefits to the president, managing director, and other members of the board of directors. This came into consideration if the state representative considered that a decision “may jeopardize the interests of depositors or substantially affect the solvency and the good functioning of the bank” (EC 2008a).

The behavioral conditions imposed on recapitalized banks included:

1. The salary and benefits of the president, the managing director and other members of the board of directors, general directors, and deputy general directors of recapitalized banks could not surpass the salary and benefits of the governor of the BoG. The law required banks to review their activities regularly and limit the remuneration of bank executives involved in a state intervention (EC 2008a).
2. Any additional bonuses were abolished throughout the duration of the recapitalization.
3. Although the Greek law allowed dividend distribution of up to 35% of distributable profits, in principle, no dividends were paid out while the Greek government was involved (ATE Bank 2010; Greece 2008b; Mayer Brown 2009). The commission declared that, based on Article 1(3) of the Greek law and by decision of the Greek minister of economy and finance, the state representative appointed at the bank board of directors would ensure through their veto rights that no dividends were distributed until government participation had been redeemed (the veto right could not be overruled). The commission noted that an important behavioral constraint was the ban on dividends, because it provided an incentive for the bank’s common shareholders to repurchase the state’s preferred shares as early as possible. Through the ban on dividends, the capital base of the bank was built by the accumulation of reserves, in line with the overall goal of the program. In cases of dividend distribution, Greek authorities notified the EC to seek its approval.
   
   In June 2009, then–BOG Governor George A. Provopoulos expressed that:
4. “In matters relating to banking supervision and financial stability there is no room for even the slightest complacency. My main priority, since the first day I took up my duties, has been to protect financial stability. In view of the increased risks resulting from the weakening economic activity, high market volatility and the prevailing liquidity conditions, I have asked banks to implement the kind of policies that ensure financial resilience, stability and health.
5. I have also urged them to make use of the government plan, so as to enhance liquidity in the economy. I have asked them not to distribute any dividends, to substantially increase their provisions for bad debts, and to reduce bonuses to their executives. All these measures create additional ‘cushions’ that shield banks in the difficult times we are experiencing. Nevertheless, continued vigilance is required” (BoG 2014).
6. Banks recapitalized had to report to the BoG every three months on the specific use of the capital injected. Based on these reports, the BoG prepared semiannual reports to be submitted to the commission that outlined the use of the capital injected, implementation of business plans, and any restructuring plans. If a bank seriously violated the terms and conditions of the recapitalization, the minister of economy and finance, following a proposal of the BoG governor, could impose sanctions or cancel government support in full or in part.
7. Banks were expected to restrain from any aggressive market strategies or advertising, particularly against competitors not receiving equal coverage or not part of the scheme.
8. Banks were expected to refrain from expanding their activities or pursuing different purposes that might unduly distort competition. Banks were forced to ensure that, during the government’s involvement in the recapitalization, the average increase of the total assets did not surpass the highest of these amounts: (a) the annual growth rate of the Greek nominal GDP of the previous year, (b) the average rate of increase of the Greek banking sector’s total assets for the 1987–2007 period, or (c) the average rate of increase of the EU banking sector’s total assets for the previous six months.

Compliance with these obligations was controlled by the Supervisory Council and based on the BoG’s reports. The Supervisory Council was set up by the Greek law and was chaired by the Greek minister of economy and finance with the participation of the BoG governor, the deputy minister of economy and finance, and the Greek state’s representatives at the boards of directors of the participating banks. The Council convened monthly to coordinate the implementation of the law and make sure depositors, borrowers, and the Greek economy benefited from the scheme (EC 2008a).

Greek law stated that recapitalized banks had to repurchase the preferred shares from the Greek government within five years and for the amount originally invested in the bank. The BoG prevented bank repurchases in cases where capital adequacy ratios were not met. If, after five years, the bank could not make the repurchase because of capital adequacy requirements, the preferred shares were converted into common shares or other similar instruments. To determine the conversion rate, the average of the market value of these securities in the last trading year was considered. For cases where the securities were not listed on an organized market, the bank’s internal book value of the last fiscal year was considered (EC 2008a).