Yannis Stournaras: Entrepreneurship, NPL resolution policies and
economic growth prospects in Greece
Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at an event hosted by Piraeus
Bank, Athens, 28 March 2017.
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It is a great pleasure for me to be here with you today and have the opportunity to share my
thoughts on the growth prospects of the Greek economy and the role of entrepreneurship and
NPL resolution policies. Today, the long-term growth prospects of the Greek economy are
significantly improved compared to seven years ago as the economy has been undergoing
significant rebalancing and adjustment, despite the missteps and delays that occur from time to
time.
The improved macroeconomic fundamentals open up significant investment opportunities.
Entrepreneurship can transform these improved opportunities in actual economic growth, new
jobs and social prosperity. Banks play an important role in providing finance to entrepreneurs to
make this transformation possible.
Greek banks have not been able so far to provide the necessary credit to companies as they are
burdened with a high share of non-performing loans (NPLs). This may change in the future due
to a number of ongoing initiatives. Resolution of NPLs may foster economic growth significantly
as it will enable a productivity-enhancing reallocation of capital and employment from non-viable
to viable companies and sectors.
Since the beginning of the sovereign debt crisis, Greece has implemented a bold programme of
economic adjustment that has eliminated fiscal and external deficits and improved
competitiveness. Between 2009 and 2016, the general government deficit shrunk by
approximately 14 percentage points of GDP. The primary balance, adjusted for the effect of the
business cycle, improved by about 17 percentage points of potential GDP. This achievement
represents one of the largest fiscal adjustments ever undertaken and is twice that of the
adjustment in other Member States that were under EU-IMF programmes.
On external adjustment, the current account also marked a significant turnaround improving by
about 15 percentage points of GDP compared to 2008; in the last two years, it has effectively
been in balance. Competitiveness has been restored, reflecting the effect of structural reforms in
the labour and product markets. As a result, the share of exports in GDP increased from 19% in
2009 to 30% in 2016 with most of this increase stemming from exports of goods. In fact,
according to Eurostat data, Greece's exports of goods have increased by 43% since 2009 in real
terms, compared to 42% for the euro area and 47% for Germany, Europe's export engine.
This rebalancing of the economy towards a new, outward-looking growth model has particular
significance for the prospects for entrepreneurship. A few figures are indicative of the forces at
work. Between 2010 and 2015, the relative price of tradables versus non-tradables rose by about
10%. Whereas both sectors have been hit hard by the recession, the tradable sector has
performed better than the non-tradable sector as outward-looking companies increased their
exports, taking advantage of the improvement in competitiveness. As a result, the relative size of
the tradable sectors, measured by Gross Value Added, grew by approximately 12% in volume
terms and by about 24% in nominal terms. Finally, in terms of employment, the size of the
tradable sector increased relative to the non-tradable sector by around 8%.
These figures would improve further if the already implemented reforms were to be enhanced by
those planned under the ESM programme. Based on estimates of the OECD, the full
implementation of all reforms, both those undertaken and those scheduled, is expected to boost
real GDP over a 10-year-horizon by about 13%. And this figure excludes a further positive effect
from structural reforms which cannot be easily quantified such as the modernisation of public
administration and the judiciary system, the strengthening of insolvency regulations and the
resolution of non-performing loans. In-house work by the Bank of Greece points to similar
estimates of the effects of structural reforms with the main effect coming from higher total factor
productivity (TFP) growth.
The strengthening of the long-term prospects of outward-looking firms requires a further
openingup of international trade, participation in global value chains and closer trade links with countries
and businesses with cutting-edge technology. In this way, inherent structural weaknesses that
hamper the market penetration of Greek products (such as product quality, protected designation
of origin and branding, red tape, etc.) can be overcome. Additionally, improved financing terms
and conditions would be forthcoming.
But prospects for entrepreneurs are also closely related to the paths taken by the various
programme reviews. After the successful completion of the first review, a positive momentum
developed which affected confidence and liquidity. A number of key indicators of economic
activity, such as industrial production, retail sales, dependent employment flows and private
consumption, improved. Bank deposits stabilised and emergency liquidity assistance (ELA) for
Greek banks fell. These developments pointed at that time to a recovery starting from the second
half of 2016 and continuing through 2017 and 2018.
This outlook is still possible in principle despite the deterioration in confidence and the weakening
of short-term indicators in recent months, which is associated with the delay in closing the
second review. For the time being, the delay in closing the second review has weakened but has
not reversed the positive momentum of economic activity. However, any further delays could
derail the recovery of the economy and put at risk the growth, fiscal and financial targets.
But entrepreneurship does not just require confidence. Reforms, that are part of the programme
measures, also need to be implemented. Particular emphasis should be put on simplifying
investment licensing procedures, reducing the administrative burden on businesses and
facilitating competition, opening up the remaining regulated professions and network industries,
modernizing and strengthening public administration, enhancing judicial efficiency, speeding up
court proceedings and of course reducing personal and corporate taxation. Emphasis needs to
be placed on restraining and restructuring non-productive spending and making a more effective
and efficient use of the public sector's assets, creating in this way incentives to increase
investment and employment which will contribute to increased potential output.
For their part, the Institutions should show more flexibility in the area of fiscal targets and
government debt relief. According to estimates from the Bank of Greece, a lowering of the
general government primary surplus target after 2020 to 2 per cent of GDP, from the 3.5 per cent
that is envisaged now, would be consistent with debt sustainability if combined with some mild
debt relief measures and structural reforms to raise potential growth. The easing of the primary
surplus targets, together with the implementation of the agreed structural reforms, would put the
necessary conditions in place for a gradual lowering of tax rates, with positive multiplier effects
on economic growth.
Finally, there is the issue of what debt relief measures. The short-term measures decided at the
Eurogroup meeting of the 5th of December last year are a positive step and are expected to
reduce public debt as a ratio of GDP by 20 percentage points by 2060.
However, to ensure the sustainability of public debt going forward, additional medium-term
measures are necessary. When the debt-to-GDP ratio is above 100%, measures that reduce
interest payments on debt can improve the ratio quicker than a rise in the primary balance. For
example, with a debt-to-GDP ratio of 180%, a 1 percentage point reduction in the effective
interest rate on debt will reduce the ratio of debt to GDP by 1.8 percentage points. By contrast, a
rise in the primary surplus by 1 percentage point of GDP lowers the debt-to-GDP ratio by only 1
percentage point (assuming that the fiscal multiplier is 0 which, as we well know, is not).
Now, the interest burden of Greek public debt is low until 2021 but increases substantially
thereafter because of payments of deferred interest on the EFSF loans and interest on new debt
issued in financial markets. An exercise done at the Bank looks at the impact of smoothing
interest payments for EFSF loans over time. The results of these simulations suggest that,
extending the Weighted Average Maturity of interest payments for EFSF loans by 8.5 years, while
simultaneously allowing primary surpluses to decline to 2% of GDP after 2020, debt sustainability
is safeguarded.
This exercise is indicative of how admittedly mild debt relief measures can have significant
effects on the debt profile with no cost for the creditors. Of course, were the interest smoothing
accompanied by higher growth, as a consequence of lower primary surpluses, then the
debt-toGDP profile and gross financing needs would be even more favourable. Alternatively, if interest
rate smoothing were to occur and the costs shared equally between Greece and the ESM, this
would also lead to more favourable outcomes.
Turning now to the role of the banking sector in providing necessary credit to finance dynamic
businesses, the issue of non-performing loans remains the greatest challenge. The stock of
nonperforming loans (NPLs) has reached unprecedented levels, with the deterioration in asset
quality being widespread. There is no doubt that one of the main drivers of the sharp rise of NPLs
has been the deep and prolonged economic recession and its impact on the financial condition of
households and the non-financial corporate sector. However, other factors related to structural
impediments also played a role: the ineffectiveness of judicial procedures; excessive borrower
protection; the preferential claims of the State and Pension Funds on the proceeds of liquidations
as against other classes of creditors; the unfavourable tax treatment of provisioning and
writeoffs; the lack of an out-of-court-workout framework; and the absence of a secondary market for
distressed debt.
The Bank of Greece and the government have implemented several measures to address the
long-standing impediments that dampened banks' efforts to deal with the problem. As a first step,
the Bank of Greece conducted a troubled asset review to assess the operational preparedness
and effectiveness of banks' established policies and practices to deal with the large scale
resolution of troubled assets. Following this, the Bank enhanced the supervisory and regulatory
framework. It issued guidelines regarding NPL management with a key requirement being the
establishment of a well-defined governance structure with an internal independent NPL workout
unit. It introduced the Code of Conduct regarding the interaction of credit and other financial
institutions with borrowers in arrears.
Recently, the Bank of Greece, in close cooperation with the banking supervision arm of the
European Central Bank, has designed an operational targets framework for the reduction of
NPLs, supported by several Key Performance Indicators. The selected targets and key
performance indicators are both action-oriented and results-oriented and provide a granular view
of the key asset quality metrics of the bank, the management actions to reduce NPEs and the
effectiveness of these actions. Banks have agreed ambitious but achievable targets, which were
submitted at the end of September 2016, with a 3-year time horizon. The goal is to reduce NPLs
by around 40 billion euros by end-2019. The targets set take into account the intrinsic
characteristics of each bank's portfolio, organization and capacity. At the same time, banks have
developed tailored models to calibrate the operational targets, taking into account
macroeconomic assumptions.
The key performance indicators are monitored on a quarterly basis through extended prudential
reporting, and the Bank of Greece, to enhance transparency and market discipline, has
committed to publish a relevant progress report every quarter. Based on the first report already
published, the targeted reduction of NPLs is on track, although the main reduction is not
expected to take place before the end of 2018-beginning of 2019.
The government, for its part, has improved the regulatory framework related to the law on
overindebted households. It has amended the Code of Civil Procedure, with a focus, inter alia, on
changing the hierarchy of creditors and how proceeds are allocated in cases of liquidation. The
capacity and efficiency of the judicial system have been enhanced, albeit with implementation
being somewhat behind schedule. In addition, the government and the Bank of Greece have
developed a framework for non-bank credit servicing firms and the sale of NPLs, with two
companies having received a license so far, while other applications are being reviewed.
The above initiatives are about to be significantly enhanced by the implementation of further
policy actions that are in the pipeline. Specifically, important steps are being taken regarding the
revision of the out-of-court workout in order to facilitate coordination among banks and other
creditors, including the State and social security funds. Significant focus will be on standardizing
procedures for small business professionals and small and medium enterprises to ensure a
rapid, effective and transparent resolution of arrears. In addition, the revision of bankruptcy law is
expected to streamline procedures, allowing for creditor-led restructuring for companies with
negative net worth, while the tax treatment of impairment losses and loan write-offs is in the final
stages of being legislated. On the remaining steps, it is important that bank managers and
employees acting in good faith in managing non-performing loans should be protected from
criminal prosecution, while the platform for electronic auctions should become operational.
Additionally, the full deployment of debt information / counseling centres across the country will
facilitate borrowers' understanding of the optimum solutions to managing their loans.
The full implementation of the above reforms, in conjunction with a more active NPL
management policy on the part of banks is beneficial from both a micro and a macro prudential
perspective. It can improve the financial soundness of banks; it will free-up capital that can be
directed to productive sectors of the economy, resulting in an increase in productivity and
potential growth. Finally, it will diminish the power of strategic defaulters who, until now, see no
immediate consequences from failing to pay. A conservative estimate, based on a sample of
13,000 firms with loans that exceed one million euro, indicates that, on average, one in six
companies appear to strategically default, while anecdotal evidence suggests that this value is
significantly higher for smaller businesses and households.
On the macroeconomic implications of NPLs, the academic literature has established a strong
two-way relationship between macroeconomic developments and asset quality. The profound
and well-documented negative relationship between economic growth and NPLs is enriched by
recent studies that also identify a negative feedback effect from the banking sector to the
economy. The size of that feedback is related to the ability of banks to channel savings to
investment, to allocate risks and to transmit monetary policy decisions to the real economy. This
ability has also been found to be related to bank-specific drivers, such as management quality,
the level of capital, cost efficiency and risk preferences.
In particular, one of the main channels through which financial developments can have a
feedback effect on the macro economy is through the capacity of banks to lend to the economy,
the so-called "balance sheet channel". The reduction in NPLs can weigh positively on the supply
of credit by unlocking bank capital and funding for the financing of productive companies. The
reduction in NPLs improves the profitability of banks through higher interest income, reduced
provisioning or write-offs and reduced administrative expenses for the monitoring and
management of NPLs. At the same time, by removing doubts about the bank's future revenues, it
allows banks to benefit from lower funding costs. Such developments positively affect loan
supply. In addition, as impaired assets carry a higher risk weight, a lower level of NPLs allows
banks to be more aggressive in funding investment opportunities, unconstrained by a scarcity of
capital or the distraction of managements' attention to the management of a large-scale troubled
assets portfolio.
In addition, a lower level of NPLs improves the allocation of credit from non-viable firms that are
kept artificially alive to viable firms. According to research by the OECD, when more industry
capital is sunk in non-viable ("zombie") firms, the average viable firm undertakes less investment
1
than otherwise . Hence, a rise in the fraction of non-viable firms in the economy crowds out the
growth of more productive firms, thus reducing the efficiency of capital allocation and causing a
slow-down in multifactor productivity growth. Simulations by the OECD suggest that reducing the
share of capital of non-viable firms in Greece to the minimum across OECD countries would be
associated with a gain in investment for a typical viable firm of 4.7% per annum. This number is
economically very significant. It is indicative of the potential gains of NPL resolution for corporate
investment, aggregate productivity and long-term economic growth. The policy implication is that
there is considerable scope for policy reforms that facilitate NPL resolution in order to improve
productivity-enhancing capital reallocation in the Greek economy.
On top of the above, the economy is also positively affected from the demand side, the so-called
"borrower balance-sheet channel". From a debt overhang perspective, non-financial corporations
with loans in arrears might have less incentive to invest in new projects in order to avoid using
the upside potential to service current debt. In addition, higher lending rates seen in countries
with prolonged NPL problems weigh negatively on credit demand. Higher lending costs drive
firms to utilise internal sources of financing, resulting, on average, in the avoidance of large
investment projects. A reduction in NPLs has the reverse effect, improving the willingness,
incentives and ability of economic agents to invest in new projects.
The practical implications of NPLs for growth opportunities are evident when looking at European
data on bank lending to non-financial corporations and households. The contraction of bank
lending is particularly pronounced in countries suffering from high levels of NPLs. At the same
time, Member States with high NPL ratios have also experienced below average GDP growth,
consistent with the below-average propensity to invest that NPLs generate. The opposite picture
is found for the Member States that exhibit a lower level of NPLs.
Therefore, the effective management of NPLs is of the utmost importance for a country's growth
opportunities. Banks - benefiting from improved asset quality, profitability and liquidity - will be in
a better position to reduce the cost of credit risk and lending spreads. This amounts to a pivotal
development for the competitiveness of the non-financial corporate sector in an international
environment of ultra-low interest rates. It also facilitates the reduction in the debt servicing costs
of households that mitigate the impact of reduced household gross disposable income. The
above is to the benefit of the real economy as the unlocking of funding and the improved
business climate impacts positively on the setting-up of new businesses, investment,
employment and growth. In sum, we would move to a virtuous circle where improved asset
quality positively affects GDP growth, in turn leading to a further reduction of NPLs and so on.
In conclusion, Greece is poised to return to economic and financial normality and to shift to a
new, outward-looking and sustainable growth model, based on tradable goods and services. The
economic adjustment and structural improvements over the past years have opened up
significant investment opportunities. To reap the benefit of these opportunities though, there are
certain preconditions: first, the completion of the second review with no further delay; second,
the consistent and determined implementation of the programme in conjunction; a more
third,
realistic approach by all parties to the fiscal mix and government debt burden. Such
developments, together with the cleaning-up of banks' balance sheets will set in motion a
virtuous circle, paving the way to the full return of the Greek economy to normality.