OREANDA-NEWS. November 10, 2015. The EUR14.4bn Greek bank recapitalisation plan is essential to strengthen loss absorption buffers but will not, on its own, be enough to restore financial stability, says Fitch Ratings. Banking sector viability will remain weak until deeper structural problems are addressed. Banks hold exceptionally large volumes of problem loans and funding structures suffer from material imbalances.

The ECB's comprehensive assessment of Greek banks, announced on 31 October 2015, identified a capital shortfall of EUR4.4bn under a baseline scenario and EUR14.4bn assuming an adverse scenario. Provided remedial actions are approved for the banks, we calculate that their average pro-forma common equity tier 1 (CET 1) ratio will reach 14.8%. Capital injections will also improve liquidity, particularly if they lead to the reinstatement of a waiver allowing the ECB to accept Greek bonds in exchange for ECB funding.

The ECB's review highlights that the four large Greek banks hold EUR112bn of non-performing exposures (NPE). This sheer volume, accounting for 63% of GDP, makes recovery daunting, especially given continued economic weakness. Prospective reform of the country's insolvency framework might speed up recoveries. Reserve coverage of NPEs has improved, but remains low at 53% or less, considering the continued decline in collateral values.

Greek banks are highly reliant on central bank funding following EUR116bn of private-sector deposit outflows since 2009, of which EUR43bn was in the last 12 months. Customer behaviour remains highly sensitive to political developments and we believe that it may take time before confidence in the banking sector improves sufficiently to allow capital controls to be lifted.

The recapitalisation process will likely be completed by end-2015. The banks intend to cover at least the baseline capital shortfalls through a combination of liability management exercises, asset sales, equity issuance and other internal measures. Fitch believes that certain senior and subordinated creditors will absorb losses. However, any subsequent bail-in of privately held senior bonds to cover capital gaps could be problematic and expose the authorities to compensation claims.

The Hellenic Financial Stability Fund (HFSF) might participate in the recapitalisation to address any capital shortfalls identified under the adverse scenario. It might be possible to treat potential HFSF injections as a precautionary recapitalisation under the EU's Bank Recovery and Resolution Directive, rather than as a resolution action, thereby avoiding the need for authorities to bail-in 8% of the banks' liabilities and own funds.