What Should Be Done with Greek Banks to Help the Country Return to a Path of Growth?

The recapitalization of Greek banks is perhaps the most critical problem for the Greek state today. Despite direct cash infusions to Greek banks that have so far exceeded 45 billion euros, with corresponding guarantees of around 130 billion euros, credit expansion has failed to pick up. There are two obvious reasons for this failure: first, the massive exodus of deposits since 2010; and second, the continuous recession--mainly the product of strongly deflationary policies dictated by international lenders. Following the 2012-13 recapitalization, creditors allowed the old, now minority, shareholders and incumbent management (regardless of culpability) to retain effective control of the banks--a decision that did not conform to accepted international practices. Sitting on a ticking time bomb of nonperforming loans (NPLs), Greek banks, rather than adopting the measures necessary to restructure their portfolios, cut back sharply on lending, while the country's economy continued to shrink. The obvious way to rehabilitate Greek banking following the new round of recapitalization scheduled for later this year is the establishment of a "bad bank" that can assume responsibility for the NPL workouts, manage the loans, and in some cases hold them to maturity and turn them around. This would allow Greek banks to make new and carefully underwritten loans, resulting in a much-needed expansion of the credit supply. Sound bank recapitalization with concurrent avoidance of any creditor bail-in could help the Greek banking sector return to financial health—and would be an effective first step in returning the country to the path of growth.