OREANDA-NEWS. Greek authorities are likely to want to see further improvements in investor and customer confidence before capital controls, introduced in June 2015, are materially eased at Greek banks, says Fitch Ratings. In our view, the economic and political environment remains fragile and confidence has not yet returned to the financial system. Our standalone viability ratings assigned to the Greek banks remain at 'f'.

Capital controls could be gradually relaxed from late 2016 if the political and operating environments are stable and Greece continues to deliver the reforms envisaged in its economic adjustment programme, in our view.

Depositor behaviour is highly sensitive to political developments. In the nine months prior to June 2015, amid uncertainty about Greece's place in the eurozone, the banking sector lost EUR43bn, or 26%, of private sector deposits. Deposits have not flowed back into the system and deposit levels remain broadly flat since June 2015. Restrictions on deposit withdrawals discourage customers from placing funds back with the banks.

A possible example for relaxing controls could be to raise the EUR420 weekly withdrawal limit per person. But it is difficult to gauge whether depositors are sufficiently confident in the banks or whether relaxation might trigger a new round of withdrawals. Volumes of banknotes in circulation increased significantly prior to the imposition of capital controls, suggesting that cash withdrawn from banks was kept in the country. Before the Greek authorities lift controls, they will assess whether depositor behaviour has changed or whether the urge to hoard cash is still prevalent.

Recapitalisations mean that the credit fundamentals of Greek banks progressed significantly since June 2015 and capital controls also protect liquidity in the system. The sector as a whole is still heavily reliant on Eurosystem funding, largely in the form of emergency liquidity assistance (ELA) channelled through the Bank of Greece. But in June 2016, the ECB reinstated a waiver enabling it to accept Greek public sector debt as collateral to access regular refinancing facilities. We estimate that Greek banks could replace around 7% of their ELA funding with ECB borrowing; while this is not a significant amount, the banks will benefit from it being a slightly cheaper form of funding.

Greek banks can also borrow under the ECB's targeted longer-term refinancing operations (TLTRO). TLTROs would lengthen the maturity profile of Greek banks' funding and reduce costs. However, TLTROs can only be used to fund new lending and meaningful new loan growth can only take place once confidence returns. We expect some further loan deleveraging in the system, reflecting banks' tight liquidity and muted demand from high quality borrowers. We forecast another year of economic contraction for Greece in 2016, with GDP contracting by 0.9%, with gradual improvement coming in 2017.