An escalation of the war in Ukraine will hurt EU’s economic outlook, ECB’s Stournaras says

An escalation of the war in Ukraine could hurt the economic outlook for the European economy, European Central Bank policymaker Yannis Stournaras said on Tuesday.

“A further escalation of the crisis in Ukraine poses a risk for the prospects of the Greek and European economy,” Stournaras, who is the governor of Greece’s central bank, told a banking conference in Athens.

Ladies and Gentlemen,

We live in a rapidly changing and interconnected economic environment, where ‘tail risks’ have significantly increased. The Russian invasion in Ukraine a few weeks ago, was the second such event within the past two years. The first was the pandemic. This ‘perfect storm’ came at a time that vulnerabilities are still elevated and both the Greek and European economies as well as their financial sectors are recovering from the effects of the pandemic.  It creates stagflationary forces and monetary policy dilemmas for the ECB as well as fiscal, energy and defense issues for the eurozone and national governments. I will not, however, concentrate on these issues during my speech as we can analyse some of them during the discussion that will follow. I will concentrate instead on the financial sector.

More specifically:

Starting with the impact from the pandemic in the asset quality indicators; so far the flow of new non-performing loans (NPLs) has been contained, as the support measures taken by the fiscal, monetary and supervisory authorities averted the defaults of corporates and households and supported the balance sheet and the profitability of the banking sector. However, the performance of obligors that have received state support after the complete phasing out of these support measures will be critical for the asset quality of European lenders. The recent spike in inflation -and especially in energy prices-, the squeeze in the disposable income and the still weak corporate fundamentals, will put more pressure on vulnerable obligors and consequently upon asset quality. The still very uncertain consequences for the banking sector of the war in Ukraine and of the disruption in the energy sector and in various supply chains are yet to be assessed.

Please allow me to provide a few additional remarks related to the domestic market; In Greece, there has been a very substantial progress over the past few years in dealing with NPLs. With end-December 2021 data, the NPL ratio has dropped to 13%, the lowest percentage seen for more than a decade. We may recall that in the peak of the crisis, the NPL ratio reached 45%, and since then the reduction in the stock of problematic loans was more than 80%. Of course, further effort is necessary for Greek banks to reach the EU avg. (2,1%), amid the aforementioned challenging economic environment.

At the same time, it is of utmost importance to see material progress regarding the resolution of private debt. The NPLs have been transferred from the balance sheet of banks, but the debt obligation is still there. Today, the amount of private debt managed by the NPLs servicers is north of €120 bn. Their goal should be:

  1. a) For the ‘non-viable customers’, to work-out the ‘idle’ collateral which should enter back to the economy and become productive again, and
  2. b) For the ‘viable customers’, to offer an effective restructuring solution that will ensure sound financial fundamentals and facilitate their re-onboarding, under certain conditions, on the banks’ balance sheets.

As already said, the prevailing conditions post the recent developments in Ukraine is another vulnerability, that could also expose European banks to market risks. Should these conditions persist, they could also impede the actions planned by financial institutions to strengthen further their capital buffers and meet their targets for MREL (Minimum Required Eligible Liabilities). In this context, Greek banks are adequately capitalized, since they managed to tap the markets over the past few years and issued common equity and other capital instruments. Being non-investment grade issuers, they are also taking a number of capital accretive measures that has allowed them to execute their NPL reduction strategies as well as to address challenges ahead such as the impact from IFRS9 transition. Planned capital actions will also improve the structure of banks’ capital and lower the share of Deferred Tax Credits in Common Equity Tier 1 capital.

Another area of concern is the sustainability of business model of several European lenders amid the low interest rate environment. We noticed that there has been a rebound in profitability of banks in the euro-area, but part of it is driven by the accommodative monetary policy, the subsidized element of TLTROs and the extraordinary, but non-permanent, income. At the same time, inelastic cost structures, overcapacities, the ability to catch-up with the technological wave, limited new business growth and competition from outside the banking system, are long-lasting structural vulnerabilities on business model sustainability.

Finally, new risks and vulnerabilities have recently emerged and gained importance such as the impact from climate change, the cyber-attacks, and the elevated risks in the non-bank financial sector.

The war in Ukraine has amplified all these looming vulnerabilities and complicated the state of play. Inevitably, the outlook for the economy and the financial sector is clouded by uncertainties and policy makers and market players may need to navigate in stormy and unchartered waters in the months to come.

However, and being optimistic in nature, I would like to give you a more positive tone about the ‘Big Picture’ for the Financial Sector in Greece and Europe.

First and foremost, I think that the European Union will emerge stronger from the recent geopolitical crisis. The level of co-ordination achieved in public health and in fiscal policy during the pandemic, and the complementarity between fiscal, monetary and supervisory policies, have been unprecedented. The same can be said regarding the common stance achieved over Ukraine. It seems that in the coming years it is more likely that we will see significant steps towards further integration across critical sectors, such as defence, energy and fiscal policy. We should not forget that Greece spends for the defence of its borders, which are also European borders, a much higher percentage of GDP than the European average. I also expect further progress in the completion of the Banking and Capital Markets Union, especially the creation of the European Deposit Insurance Scheme. The latter will have a positive impact in the banking system in the euro area, including Greek banks. Among others, it will facilitate cross border consolidation of banks. Also, initiatives to unify the banking crisis management framework in the euro area and to contain “ring fencing” is expected to increase the efficiency and enhance the profitability of European banks. Usually, in such issues the euro area witnesses different views between ‘North’ and ‘South’: The ‘North’ wants to see risk reduction measures first before it concedes risk-sharing measures. The ‘South’ wants the opposite. Why not pursuing them simultaneously? Why should we behave as if we have a zero-sum game to solve and not a co-operative, win-win one? Let us extend the experience we gained during the pandemic in all open issues we face in the euro area!

Moreover and leaving the impact from the current turmoil aside, there are strong tailwinds for the Greek economy. In 2021, real GDP increased by 8,3%, driven by the strong growth rates of exports of goods and services, gross fixed capital formation and the rebound of private consumption.  At the same time, labor market developments are favorable with employment growth picking up and unemployment declining.

Looking forward, NGEU funding, pent-up demand and the rebound in tourism are expected to be the three main drivers of the recovery. For NGEU in specific:

  • Greece is entitled to receive more than €70 bn of EU funds over the next seven-years. About half of these funds (€30.9 bn) are related to the EU Recovery Plan (NGEU). The rest is structural funds from the EU budget 2021-2027.
  • NGEU funds are targeted at growth-enhancing high value-added projects in the areas of energy saving, the transition to green energy, the digital transformation of the public and the private sector, employment, social cohesion, and private investment.
  • According to BoG estimates, full execution of the EU Recovery Plan will contribute to a significant increase of 7% in real GDP by 2026, primarily due to the increase in total investment and total factor productivity. At the same time, it will contribute to the increase of employment, private investment, exports and tax revenue.
  • Τhe implementation of the reforms associated with the NGEU will bring about a permanent increase of real GDP and total factor productivity (in the course of ten years).
  • It will also create significant lending opportunities for Greek banks.

Finally, if the efforts to achieve investment grade for the Greek Government Bonds turn out to be successful within the next twelve months, this will be extremely beneficial for the Greek Banking Sector as well.

Concluding, the road ahead is not paved with roses as the scars from the pandemic are still open, whereas new and unforeseen challenges are more than looming. The implications of the Russian invasion of Ukraine pose an important adverse supply side shock, which is expected to negatively affect output and further increase energy prices. In addition, a potential further escalation of the crisis poses notable unfavorable risks to the outlook for the economy.

In the years to come, the banking sector could and should play a pivotal role in the pursuit of sustainable economic growth and the transition towards a green economy, creating value for the environment and the society alike.