How does financial power evolve in the age of financial excess, when it comes to a late-liberalizing financial system, of a statist, credit-based, southern European capitalist economy (Amable Reference Amable2003; Featherstone Reference Featherstone2008)? When we are looking to answer this question, the case of Greece can contribute important comparative insights of the structural limitations of financial power in the European periphery.
Why ‘structural’ limitations? As with other contributions in this special issue, the term ‘structural’ denotes the sheer weight of finance in the makeup and functioning of a capitalist economy. There is a structural quality in the weight of finance in the sense that is not simply a function of the bankers’ elite status or organization as a lobby group; more than that, the structural weight or power of finance derives from its indispensable role in providing the vital liquidity and capital with which any modern economy ‘breathes’, functions and grows. Being a structural derivative of the way a capitalist economy is organized, the power of finance as such is directly affected by the changing institutions and structures of this economy, and more specifically by the changing organization of the state–finance relationship. The institutional framework underpinning state–finance relations and the exact nature of the financial regime (interventionist or liberalized) affects the power of financial capital in a structural sense. The power of finance is structurally circumscribed under credit interventionism and financial repression, and it is greatly enhanced under financial liberalization and capital mobility.
Formerly subject to developmentally oriented financial interventionism, the Greek banking sector gradually came to acquire formidable power following financial liberalization in the early 1990s, culminating in the financial boom decade of 1998–2008. Financial liberalization itself did not result from the lobbying power of bankers, as was the case in countries with developed financial systems (Kurzer Reference Kurzer1993; Moran Reference Moran1984). Rather, it was exogenously led and also driven by the national central bank as a key prerequisite for establishing monetary policy effectiveness in combating inflation. Governments in the early 1990s were forced to accept the higher interest rates that resulted from credit deregulation as the inevitable price of acceding to the single financial market, also allowing monetary policy to carry the brunt of macroeconomic adjustment towards achieving the Maastricht convergence criteria. Towards the end of the 1990s, however, and especially under the euro, the decline of interest rates allowed the cheap funding of government budget deficits. In addition, the rapid credit expansion under the euro, as well as from multiplying banking sector profitability, also served a government objective of delivering instant (and politically effortless) societal prosperity.
The mutually convenient model of debt-driven growth, however, was circumscribed by the limits of macroeconomics and the structural constraints of a high-deficit over-indebted economy operating within a monetary union. The Greek debt crisis mainly resulted from the sovereign sector, given that the stock of private debt remained comparatively limited. Thus, in the case of Greece, the crash that followed the 2008 global financial crisis was not a direct result of banking sector excesses, to the extent witnessed in Ireland, Spain or even Portugal. Rather, the Greek crisis ensued primarily as the meeting point of two crises: a euro area structural crisis, associated with the widened macroeconomic imbalances between core and periphery against the backdrop of systemic financial instability; and a twin domestic crisis emanating from unsustainable public borrowing levels and a massive current account deficit that could no longer be financed through cross-border capital inflows.
Starting from the public sector, the crisis spread to the banking sector and back again, in a self-feeding vicious circle of contagion between sovereign, banking sector and the real economy. The banking sector emerged severely bruised by the crisis, in all its forms. The story will be explored in more detail in the sections that follow.
Developmental Finance: The Roots of Credit Interventionism Prior To The Liberalization (1950s To Late 1980s)
Until the financial liberalization of the early 1990s, Greece posted a bank-based or credit-based financial system (Zysman Reference Zysman1983) that was part of a post-war model of development-oriented financial interventionism over the post-war decades. After 1946, financial interventionism was a form of taxing the banking sector that serviced a concatenation of state objectives. It redistributed resources among sectors, rationed credit or suppressed it to protect monetary stability, or ensured that it flew in abundance where needed for productive purposes, keeping finance away from sectors deemed ‘unproductive’, such as consumption, import and domestic trade and housing. It nurtured infant industries as well as smaller manufacturing enterprises producing consumer goods, thus becoming an effective tool of import substitution industrialization. After the 1960s, financial intervention propped up the tradables and export sector through generous credit and other subsidies, expediting the gradual shift towards an increasingly extrovert model of industrialization. Through the post-war period, financial intervention also funded public investment in the national infrastructure required for development. Being amenable to particularism and electoral expediency, credit interventionism also became a potent instrument for the politically minded selective distribution of finance (Loriaux Reference Loriaux1997; Pagoulatos Reference Pagoulatos2003a; Perez Reference Perez1997; Shonfield Reference Shonfield1965; Woo-Cumings Reference Woo-Cumings1999).
In other words, financial interventionism served as the institutional apparatus that directed national savings exclusively into the national banking system and subsequently transformed bank deposits (trapped in national banking systems sheltered by capital controls and market protection) into low-interest credit for ‘productive’ sectors, industrial enterprises and, most notably, the government itself (Deeg and Perez Reference Deeg and Perez2000). Indeed, in southern European economies characterized by fiscal deficits and balance of payments deficits largely resulting from weak tax bases, financial interventionism ‘taxed’ the domestic banking system and depositors in order to secure cheap government finance.
However, the inflationary environment of the post-1973 period undermined the usefulness and effectiveness of financial interventionism. Through the crisis of the 1970s and into the first half of the 1980s, credit interventionism was divested of its developmental and stabilization functions. In an effort to ease the supply-side shock, nominal interest rates rose at a far slower pace than the galloping inflation, becoming negative in real terms. That was in direct contrast to the post-war use of credit policy with a commitment to monetary stability. By becoming inflationary, credit intervention was also shorn of its developmental role as – instead of financing new investment – copious bank credit was extended to cover short-term operational needs in order to keep alive the hard-hit industrial enterprises (many of which were gradually nationalized). Thus credit interventionism allowed the state to provide painless short-term solutions to the crisis, postponed the necessary adjustments, underwrote a generation of ailing and over-leveraged industrial firms and burdened the state-controlled banks (SCBs) with a chain of bad loans and failing industrial subsidiaries. Most crucially, negative real interest rates and compulsory investment requirements sustained high inflation and easy government finance, amounting to a soft budget constraint. Thus they contravened the secular orthodoxy, on the ascendant in the EC/EU through the 1980s, of curtailing inflation and fiscal deficits.
Economic Stabilization and Disinflation Via Financial Liberalization (1987–98)
Financial liberalization in Greece was gradually initiated in the late 1980s and early 1990s at a time of double-digit inflation and fiscal deficits. Several measures had cleared the ground, but the year 1987, when the short-term lending rate ceiling was abolished, can be taken as the symbolic initiation of credit deregulation, implementing the European single market programme. It has been argued (Pagoulatos Reference Pagoulatos2003b) that financial liberalization in Greece (and Spain and Portugal) was, to a significant extent, state driven, being a necessary prerequisite for the central banks’ programmatic effort to achieve effective disinflation. The central bank’s effort to disinflate from the second half of the 1980s and especially into the 1990s drove liberalization; financial reform was a precondition for monetary austerity. Moreover, under European, external, or purely domestic economic pressure, the Greek government tolerated or embraced monetary reform for its advantage in offsetting the government’s own more reluctant pace in fiscal tightening.
Generally, central banks favoured financial liberalization because it increased their policy autonomy towards government, improving their ability to conduct monetary policy unhindered by government interventions, even though the completion of capital liberalization would surrender that autonomy to the international markets. The emergence of persistent deficits and inflation since the 1970s had dramatically altered the conditions for the effective exercise of monetary policy. Direct credit controls were becoming increasingly incapable of stabilizing the economy, government-administered interest rates prevented central banks from applying their own interest rate policy, and special compulsory investment ratios precluded the central banks from exercising effective monetary control. Government securities forced upon the banking system at a government-determined interest rate forestalled the central banks’ exercise of open market policy (that is, buying and selling government paper). Only a developed money market, the underlying central bank view held, would allow effective control of monetary aggregates by enabling the central banks to continue their regular unobstructed response to short-term liquidity changes. Liberalization removed the constraints of interventionism, allowing central banks to employ their indirect monetary policy instruments more effectively towards disinflation and to respond more flexibly to the restrictive conditions of the international markets (International Monetary Fund 1995; Padoa-Schioppa Reference Padoa-Schioppa1994). Thus, under that orthodox logic, capital markets were viewed not as the destabilizing factor that they would turn out to be, but as a strategic ally in the central bank’s effort to rid itself of inflationary government encroachment in its conduct of monetary policy.
The central bank’s programme of disinflation through financial liberalization evolved against the backdrop of international deregulation. Through the 1970s and 1980s international capital movements were gradually liberalized, putting pressure on smaller economies which had not yet liberalized their capital account to do so (Eichengreen Reference Eichengreen1996; Forsyth and Notermans Reference Forsyth and Notermans1997; Frieden Reference Frieden1989; Helleiner Reference Helleiner1994; Simmons Reference Simmons1999). If real interest rates remained negative or at lower than market levels, and the national financial system was not competitive and efficient enough, then (when capital controls were lifted according to the EU programme) savings would flow out and the balance of payments would collapse. Thus, the prospect of capital liberalization necessitated the completion of domestic financial liberalization. The other component of the ‘external constraint’ was the particular ‘positive’ institutional obligations imposed by the European single financial market programme. In a subsequent wave of institutional reform came the Economic and Monetary Union (EMU) programme, accession to which was contingent on the national currencies’ participation in the European Monetary System (EMS). The combination of liberalized capital movements and stable exchange rates necessitated the full alignment of national monetary policies behind the European Monetary System, even for those EC/EU member states that had not yet entered the European Monetary System (Eichengreen and Frieden Reference Eichengreen and Frieden1994).
Driven by the self-constraining force of financial liberalization, the non-accommodative monetary policy (‘hard drachma’ and high real interest rates) in Greece was inaugurated in 1990 by the centre-right New Democracy (ND) government. It continued with new vigour under the socialist Pan-Hellenic Socialist Movement (Pasok) governments after 1993, attaining the objectives of entering the Exchange Rate Mechanism (ERM) of the European Monetary System (1998), and fulfilling the European Monetary Union nominal convergence targets through which Greece joined the euro (2001). Over the 1990s, financial liberalization led macroeconomic adjustment and disinflation in two closely related ways. First, as mentioned, financial liberalization was the precondition for allowing monetary policy to become assertive and carry the brunt of stabilization. Liberalization allowed new instruments of monetary management to be introduced. It enabled the Bank of Greece (BoG), the national central bank, to rely flexibly on open market operations, seeking to influence short-term interest rates in the interbank market as its main intermediate goal. Second, financial liberalization allowed a greater role for private investors in public deficit financing, which imposed stricter discipline in the conduct of monetary and fiscal policy. Private investors subjected government policy to greater market scrutiny. Market rates instead of ‘repressed’ interest rates raised the cost of public debt financing, until the second half of the 1990s, when it started to de-escalate.
Financial liberalization, the dismantling of the direct state–finance connection, had momentous implications. On a state sovereignty level, it completed the alignment of the national economy to the European and global policy norms and financial market forces. On a macroeconomic level, it meant accession to the primacy of disinflation, and its pursuit through indirect instead of direct monetary instruments –which also implied the erosion of expansionary policies. On a socioeconomic level, financial liberalization brought a significant reallocation of economic (and thus, one might say, political) resources from sectors traditionally favoured for developmental or redistributive purposes (manufacturing industry, small to medium enterprises, agriculture) to an increasingly emboldened financial sector and mobile, globalized business capital. On a political and ideological level, financial liberalization also generated the forces that would buttress the disinflationary orientation. Financial deepening promoted a rentier mentality and a wide number of stockholders and eventual stakeholders in ‘sound finance’ and macroeconomic discipline. Finally, at the level of institutional architecture, financial liberalization had important regulatory implications, as monetary and banking policies were transferred from the sphere of government intervention to the regulatory jurisdiction of an eventually independent central bank (Pagoulatos Reference Pagoulatos2003a: 200–1).
Liberalized Banking and Finance in The 1990s: The Rise of The Bankers
It was not an independent political strengthening of the banking sector that brought about the rise of the bankers. Quite the contrary: the banking industry in its majority remained tightly controlled by government, a political lame duck. It was rather the reverse process that took place: the banking sector emerged stronger as a result of Bank of Greece- and state-led monetary reform and liberalization.
The specific pattern of liberalization-cum-disinflation from a central bank standpoint also resolved the fundamental conflict of allegiance of a ‘Janus-faced’ central bank, turned towards public/government objectives on one side and the financial sector on the other (Moran Reference Moran1984: 46–7). The programme of disinflating through releasing interest rates upwards served both the ‘public’ objective of disinflation and eventually the commercial banks’ preference for market-determined interest rates. Indeed, both the Bank of Greece and commercial banks shared a common interest in abolishing fixed interest rates and obligatory investment requirements imposed on bank deposits. And, like central banks, commercial banks in general are negatively disposed towards high and unpredictable rates of inflation, which erode their real interest earnings.
Powerful and internationally competitive financial sectors in countries with established financial markets (US, Britain, Germany, the Netherlands) were principal sources of pressure to liberalize. This was not the case in southern Europe and Greece in particular, where financial markets were credit based (Zysman Reference Zysman1983) and heavily underdeveloped, and the national banking sectors were relatively weak, largely state-controlled, over-protected and domestically oriented (Gibson and Tsakalotos Reference Gibson and Tsakalotos1992). They were anxious about the potential effects of capital liberalization. While south European banking sectors favoured the abolition of restrictions on their portfolios and policies (such as obligatory investment requirements, credit controls and interest rate ceilings), they feared that liberalization could erode their comfortable oligopolistic margins, forcing them to compete with each other and with far more efficient European banks. Hence, the state-controlled banks of Greece (encompassing the large majority of the sector) were reluctant if not hostile towards reform, which by the early 1990s was promoted only by a couple of small private banks. In the Greek context it was not banking pressure that brought about financial liberalization.
That said, liberalization eventually served the interests of the financial and banking sector, vesting them with considerable strength. After liberalization, banks reaped remarkable profits by colonizing the new financial markets and institutions. Liberalization (especially after controls on short-term capital movements were lifted in 1994) advanced banking interests by lifting restrictions and multiplying profit opportunities. The abolition of exchange controls and freeing of capital movements increased potential for arbitrage and fees earned through handling international financial transactions. The government recourse to public debt markets enhanced the banks’ bargaining power, given their role as principal buyers and dealers of government paper. They were able to place their assets on risk-free government securities (or so it then appeared to be) and to negotiate not only market rates but also other significant business deals (underwriting privatization schemes, co-financing large infrastructure projects, and so on).
Overall, the financial sector was a principal supporter, recipient and beneficiary of financial liberalization. Not only did the financial sector’s share of participation in the economy grow, but the intra-sectoral balance between credit and financial services was radically altered to the latter’s benefit. However, the effects of reforms exhibited a positive-sum quality for the entire financial system. Incumbent actors such as banks improved their standing compared with the pre-deregulation period, by also expanding through financial subsidiaries (such as mutual funds, portfolio investment, securities companies, and so on) into new highly profitable areas. Existing banks were the first to colonize, through specialized financial subsidiaries, the newly emerging financial sector. At the same time, a growing number of new actors and institutions emerged, responding to the broad range of new authorized services.
Income from the management of investment and pension funds controlled by the larger banking groups assumed important proportions in Greece, as they did throughout the euro area. In 2000, the majority of mutual funds operating in the Greek market were banking group subsidiaries. Moreover, the copious windfall income achieved from securities trading, especially during the Greek stock market boom of 1998–9, allowed state-controlled banks previously burdened with bad debts to clean up their portfolios and list very high profits. This, among other things, enabled the National Bank of Greece (NBG), which in the 1980s had suffered greatly from government-imposed financial burdens, to become the ‘national champion’ of Greek banking.
Furthermore, the phasing out of the compulsory investment ratio in Treasury bills (completed in 1993) brought about an important transfer of power from government to the banks. It allowed banks to demand an attractive yield in order to absorb the new issues of government paper (mostly short-term until the late 1990s). It also gave them the possibility of redeeming any government securities reaching maturity, or of selling them when short of liquidity, or of replacing them with loans to the private sector if that was deemed more profitable. Banks were paid substantial commissions for all debt issues and redemptions they intermediated. By expanding the range of alternative investment opportunities, deregulation allowed banks and savers an increasing role in defining the terms under which the government could sell its securities, progressively divesting the government of its privileged access to finance.
A brief descriptive parenthesis is due here on the Greek banking system, traditionally highly concentrated, oligopolistic and state-controlled. The country’s largest commercial bank, the National Bank of Greece, has been government controlled for over a century. State control over commercial state-controlled banks was mostly indirect, exercised through the ownership of the majority or a controlling share of their capital by a number of public sector entities and welfare funds. The majority of the Greek banking system until the mid-1990s remained state-controlled, with the government appointing the management. With the exception of two minor banks in the early 1990s, bank privatizations did not begin until the second half of the 1990s.
A small and exclusive lobby, the bankers (the subjection of state-controlled bank managers to government control and replacement notwithstanding) could often act in a coordinated way by virtue of the sector’s concentration and oligopolistic structure. Apart from the closeness cultivated through extensive informal contact, there was important common ground on which bank interests objectively converged. Although government-appointed and subject to government pressures, the managers of state-controlled banks acquired increasing autonomy after liberalization, and their bargaining power in the face of political pressures was relatively enhanced. Stronger banks were able, in exchange for purchasing a new issue of government paper, to demand, for example, a piece of favourable regulation or their inclusion in key public sector projects or other lucrative arrangements. Bargaining of this type was not exclusively reserved for state-controlled banks; the two or three major privately owned banks could also engage in such forms of exchange. Banking liberalization and marketization transformed the statist politics of bank–government relations into a perhaps equally oligopolistic (in terms of the small number of sectoral players) structure of relations, but one in which banking market actors were substantially better resourced and the state divested of crucial interventionist instruments held in the past. For its part, the government – after the high interest rates of the early post-liberalization period began to de-escalate during the late 1990s – welcomed the cheaper, diversified and longer-term funding opportunities for its persistent budget deficits.
A Banking Bonanza and The Political Attractiveness of Liberalized Finance (1998–2008)
Ironically the post-liberalization experience belied the assertion that liberalization is better for monetary control. By allowing banks to begin to market credit aggressively, liberalization was accompanied by the rapid growth of monetary aggregates, which in the interventionist regime were strictly controlled. Indeed, liberalization has been typically accompanied by financial bubbles, evident in real estate and consumption.
Among the principal defaults of a liberalized or capital-market-based financial configuration is that increased financial competition encourages speculative activities (such as foreign exchange speculation and speculative maturity mismatching) that are unproductive and may also be destabilizing (Strange Reference Strange1986, Reference Strange1998). Such problems loom larger in shallow capital markets (such as that of Greece), where manipulation and gaming become easier. The availability of a wide array of highly liquid (and potentially more profitable in the short run) portfolio investment options undercuts long-term productive investment. A liberalized financial system should ideally provide financial instruments that support productive industrial activity. In reality, it more often ends up directing funds to short-term profitable financial assets instead of investment in the real economy. Moreover, there is a significant risk of credit liberalization (combined with low interest rates) leading to a consumption boom, financed by excessive private sector indebtedness, which at a subsequent stage may act as a drag on growth, amplifying downturns.Footnote 1 The possibility that a liberalized financial system may end up behaving in a pro-cyclical manner had raised concerns in the central banks before the crisis, about targeting interest rates not only against high inflation but also against excessive borrowing (Bank for International Settlements 2001: 130ff). In sum, the real economy can be adversely affected by financial liberalization and competition (Eatwell and Taylor Reference Eatwell and Taylor2000; Gibson and Tsakalotos Reference Gibson and Tsakalotos1994; Helleiner Reference Helleiner1996; Rodrik Reference Rodrik1998). Such effects were indeed exhibited in the pre-2008 credit boom and financial bubble and the post-2008 crash.
The market impact of financial liberalization in Greece in the 1990s was visible in many ways. Equity capitalization rose from 2 per cent of GDP in 1985 to 15 per cent in 1994 and to 169 per cent in 1999, receding to 98 per cent in 2000 following the correction of stock prices. Financial liberalization in Greece notably increased the role of the capital market but did not reverse the financial system’s bank-based character. As the belated decline of the interest rate spread helps to demonstrate, liberalization increased bank competition in interest rates, but with a significant time lag. Falling lending rates and more aggressive banking competition animated demand for credit (which had been suppressed by the high interest rates over much of the 1990s). Consumer credit grew at an average annual rate of 41 per cent over the period 1994–2000, but the ratio of consumer credit to GDP in 2000 was only 4.5 per cent in Greece compared with 10 per cent in the euro area. Similarly, the corresponding ratio for mortgage lending in 2000 stood at about 8 per cent compared with an EU average of 40 per cent. The rate of growth of lending to industry was considerably slower. With the total percentage of lending over bank assets still one of the lowest in the EU, bank credit in Greece was bound to grow significantly in the European Monetary Union framework.
In the liberalized environment the banking system boomed. In the period 1990–2006, the total bank output increased significantly by an annual average of 6.6 per cent, a growth rate more than double the respective rate of GDP (Athanasoglou et al. Reference Athanasoglou, Georgiou and Staikouras2008). During 1997–2007, according to European Central Bank data, total annual growth of bank lending averaged 18 per cent, attributed mainly to the housing and consumer credit boom. In particular, average annual bank lending for housing purchases reached 28 per cent, in 2007 absorbing 35 per cent of the total economy’s bank lending, up from 15 per cent in 1998. Consumer credit recorded an annual average growth rate of 29 per cent, and its share in the economy’s total bank lending increased by about 10 percentage points – from 6.5 per cent in 1998 to 16 per cent in 2007 (Pagoulatos and Triantopoulos Reference Pagoulatos and Triantopoulos2009).
These two sectors of the economy, housing and consumption, served a demand-side growth orientation that was sociopolitically convenient for the government. Credit-driven, demand-led growth was politically popular, and the high growth rates achieved up to 2008, combined with the low interest rates, generated the kind of complacency that allowed governments to eschew necessary supply-side structural reforms. Moreover, credit expansion was only up to a point the necessary compensation for fiscal consolidation, given that primary budget deficits were abandoned after 2002. Following its accession to the Economic and Monetary Union, the state neglected the fiscal and structural measures that could countervail the inflationary politics of cheap credit. Indeed, throughout the 2000s, Greece posted higher inflation rates than its euro area partners – albeit far lower than in the 1970s and 1980s. As pointed out by Dellepiane et al. (Reference Dellepiane, Hardiman and Las Heras2013), domestic inflation is strongly associated with the expansion of construction activity, as low interest rates incentivized new borrowing and EU creditors sought high returns by lending to the growing euro area periphery. The state promoted, among others, fiscal incentives (tax reliefs, special funding regimes, and so on) that enhanced housing activity. The credit boom was economically and politically expedient as an engine of economic growth, consumption and prosperity at the potential expense of borrowers’ future earnings and the economy’s future prospects in the event of a downturn.
The political dimension denotes a government pattern, since the 1980s, of meeting societal expectations through government borrowing. In the cheap credit conditions under the euro, government borrowing was further facilitated, while an additional instrument of delivering instant societal prosperity was added, the ‘privatized Keynesianism’ (Crouch Reference Crouch2009) of private sector borrowing as a means of addressing housing needs and satisfying present consumption aspirations. To be sure, government reliance on such ‘privatized Keynesianism’ in the Greek case was relatively limited, compared with other EU economies. This was due to the already high percentage of home ownership, and the southern European structures of ‘familialism’ as well as extensive public sector employment operating as a social safety net substituting for the inadequacies of the welfare state (Karamessini Reference Karamessini2008). In the Greek case, as mentioned earlier, the growth of private debt was not a substitute or a compensation for fiscal consolidation, but grew in parallel with the persistently high levels of public sector indebtedness.
The development of the Greek financial system was based on the banking market which, in contrast to other EU financial systems, remained the dominant component. Thus, together with the expansion of the financial system (whose total assets doubled from equal to twice the size of Greece’s GDP between 1995 and 2009), the share of credit institutions’ assets to total financial system assets also increased from 81 per cent to 96 per cent (Figure 1). This upward trend (enhanced after the 1998 accession to the European Exchange Rate Mechanism/European Monetary System and the 1998–9 stock market boom) indicates the persisting dominance of banks in the Greek financial system.
A Bank-based Financial System (assets per cent of GDP) Notes: The graph shows total financial system assets as a percentage of GDP, including credit institutions’ assets, investment funds’ assets, and pension funds’ and insurance corporations’ assets. Data for the year 1996 are not published in the European Central Bank reports. Source: European Central Bank data 2003–10.
Such a favourable environment, both in terms of credit demand and in terms of supply (financial liberalization and low interest rates in the euro area), led to the further strengthening of the importance of the banking sector in the economy. During the 1997–2008 (pre-crisis) period, the number of credit institutions and employees in these institutions increased by 20 per cent and 17 per cent, respectively, while the number of local banking branches expanded by 63 per cent. The structural expansion of the Greek banking market enhanced the ability of banks to correspond to and further fuel the demand for credit, and to mobilize the debt-driven growth process in a period of widespread complacency regarding financial risks.
Total banking system assets from near 100 per cent of GDP in 1997 had almost doubled by 2009, reaching 200 per cent of GDP (Figure 2). Rapid credit growth notwithstanding, Greece’s stock of private debt and level of banking development remained lower than the corresponding levels in Europe; total banking system assets from 242 per cent of GDP in the EU and 230 per cent of GDP in the euro area in 1997 reached 357 per cent and 334 per cent, respectively, in 2009.
Apart from the rapid rates of credit expansion, the post-liberalization growth of the Greek banking sector was also based on the expansion of Greek banks to the financially ‘pristine’ emerging economies of south-eastern Europe – especially after 2000 (Pagoulatos and Triantopoulos Reference Pagoulatos and Triantopoulos2009). The credit boom, still moderate in comparison with other European economies, gave the Greek banking groups high levels of profitability, with their pre-tax profits growing by 15.7 per cent on an annual basis during the period 2000–7 (Bank of Greece 2008a). The high profitability of the banking sector was reflected in the stock market indices; before the crisis, banks were the driving force of the stock market growth (Figure 3). After the mid-1990s and until 2009, the banking sector was the flagship of the Greek stock market, the FTSE/ATHEX-CSE Banking Index being much higher than the ATHEX Composite Share Price Index. Domestic and foreign investors seemed to count on the ‘emerging’ market’s high growth potential and on the high returns from expansion to the Balkans.
ATHEX Composite Index and Banking Index, 1994–2012 Source: Athens Stock Exchange (2013).
Competition in the Greek banking system and its integration with the European market remained relatively low. The interest rates of many categories of loans were higher than those of other European banking markets, even though the spread between Greek and European interest rates was steadily decreasing (Bank of Greece 2008a). The concentration of the banking market grew. Between 1997 and 2007, the share of the five largest banks increased from 56 per cent to 68 per cent (European Central Bank data 2003, 2004, 2005, 2006, 2007, 2008, 2009). These findings too suggest a further strengthening of the banking lobby.
No Brakes: Cheap Credit and Debt-Driven Growth Under The Euro
In the cheap credit period under the euro, the banking sector expanded rapidly. Banking sector profitability rose, driven by the credit expansion to emerging areas that had been previously underdeveloped, most notably consumer and mortgage credit. At the same time, the copiously flowing cheap credit, directed from the euro area core to the peripheral economies, generated a moral hazard-type situation – one that amounted to both a soft budget constraint for the public sector and uninhibited capital inflows which funded the growing current account deficit. This was covered largely by (unproductive) capital inflows (mostly portfolio investment) and borrowing, and far less so by productive foreign direct investment inflows as was the case in other southern European countries. By 2008, Greece represented the euro area’s worst case of a twin deficit economy, as its current account deficit increased to 15 per cent of GDP, while the average fiscal deficit of the 1999–2009 period exceeded 6 per cent of GDP (Hardouvelis Reference Hardouvelis2012).
Under declining credit costs (the Greek sovereign spread between 2001 and the end of 2007 usually hovered around 10 basis points above the German bund, suggesting a market perception of negligible credit risk), the net borrowing rate of the economy expanded rapidly. Greece’s net foreign debt (net investment position), which had been 3 per cent in 1997, had reached 86 per cent of GDP by the end of 2009 (European Economic Advisory Group 2011: 109). This suggested that the Greek economy had become over-indebted to the rest of the world in order to finance a growth model which (being based on a bloating of imports, consumption and the non-tradable sector of the economy) was not sustainable. (The net foreign debt stock can be roughly understood as the cumulative sum of the annual rate of the economy’s net borrowing.) Between the mid-1990s and 2007, the Greek economy registered one of the highest average annual rates of GDP growth in the euro area and the EU. During 1996–2006 the average GDP growth rate was over 3.5 per cent, while the average level of the economy’s total net borrowing exceeded 7 per cent of GDP – mainly after accession to the euro. With hindsight, it appears that much of this corresponded to a case of debt-driven growth (Figure 4). The pivotal role of the financial system and cheap credit in leading that process needs no further expounding.
Debt-driven Growth Note: Net lending (+) or net borrowing (−) of total economy (per cent of GDP at market prices) and real GDP growth rate. Net lending (+) or borrowing (−) of the total economy represents the net sources that the total economy makes available to the rest of the world (if it is positive) or receives from the rest of the world (if it is negative). Sources: Eurostat (2013) and European Commission (2013).
Much of that income growth was either channelled out of the country (through a large increase of imports) or led to an over-expansion of the non-tradable sectors of the economy, at the expense of exports and the traded sectors. This transfer of resources from the traded to the non-traded sectors of the economy was reflected in the gaping current account deficit, suggesting a relative loss of competitiveness vis-à-vis Greece’s trading partners. The higher banking sector returns delivered by activities such as consumer and mortgage credit, typically belonging to the non-traded sector of the economy, was a significant driver of this cross-sector redistribution process.
In addition, for every single year since its accession to the euro, Greece exhibited higher than euro area average inflation, which was also crucially attributed to the demand boom created by credit liberalization and low interest rates. As a cumulative result, over the 2000s, Greece suffered an estimated real exchange rate appreciation of 25–30 per cent, leading to declining competitiveness and the huge 15 per cent of GDP current account deficit of 2008.
Debt-driven growth underwrote the over-indebtedness of the economy, mainly regarding public debt. This led to the lending crisis of 2010, following the steep contraction of GDP and the investors’ flight from sovereign debt deemed as highly risky and even from healthy private borrowers located in high-risk countries undergoing a balance of payments crisis (Pisani-Ferry et al. Reference Pisani-Ferry, Sapir and Wolff2013). Between 1995 and 2008, total debt more than doubled and reached around 230 per cent of GDP (Figure 5). Initially, the largest share was that of public debt. However, following accession to the euro and the significant reduction of funding costs, the private debt to GDP ratio increased and surpassed that of public debt. Thus, in the decade after 1995, private debt had almost tripled, reaching 90 per cent of GDP in 2005 and equalling the public debt to GDP ratio in 2007. This upward trend was maintained until 2010, when the spillover effects of the sovereign crisis seriously hit the banking system and the real economy, freezing credit expansion and investment.
The increased contribution of the banking sector to the indebtedness of the private sector relative to the public sector, following Greece’s accession to the Economic and Monetary Union, is depicted in the evolution of the credit expansion index (Figure 6). Before monetary union, credit expansion to both public and private sectors increased by a minimum rate of 5 per cent. However, during 2000–8, credit to the private sector expanded annually by an average of 20 per cent, while credit to the public sector shrank by an annual average of 3 per cent. During this same period, the government, encouraged by the low interest rates, was increasingly turning to the international debt markets to finance its deficits. From the year 2000 until the crisis, Greece’s predominantly domestically held public debt became foreign-held, increasing the country’s dependence on its foreign creditors. The trend changed after the financial turmoil of 2008, when the domestic financial sector (amidst credit crunch and capital flight) became the main lending source of the general government sector, crowding out the private sector.
The high levels of indebtedness of the private sector were not translated into investments in sectors of potentially high added value. During 1994–2012 the share in total private credit of sectors with high added value, such as industry, decreased by half, while the share of sectors such as housing and consumption more than tripled (Figure 7). The share of mortgage loans in total credit to the private sector increased from 10 per cent in 1994 to 33 per cent in 2012 as a result of the broader reduction of interest rates following accession to European Monetary Union (1999 seems to be the crucial year of this upward trend). Furthermore, there was a parallel increase in the share of consumer credit to total credit from 3.3 per cent in 1994 to 13.3 per cent in 2012, contributing to the excessive levels of consumption in the economy. Apart from the significant downward trend – considering the share of credit to the private sector – of the industrial sector (from 25.6 per cent in 1994 to 9.7 per cent in 2012) and the trade sector (from 17.3 per cent in 1994 to 9.7 per cent in 2012), a major reduction is also observed in credit to agriculture, while the share of credit to the ‘flagships’ of the Greek economy, tourism and shipping, remained roughly unchanged.
Domestic Credit Allocation to the Private Sector (per cent of total) Note: The graph shows percentage share of total domestic credit to the private sector. The sectors’ analysis before 2000 is limited only to these four sectors. Source: Bank of Greece (2000, 2001, 2002b, 2003b, 2004b, 2005b, 2006b, 2007b, 2008b, 2009, 2010, 2011, 2012b, 2013).
One sector of the economy that gained ground in terms of total channelled private sector credit – alongside consumer credit and mortgage loans – was construction, which during 2000–12 absorbed around a quarter of the credit to other enterprises (construction, electricity, gas, water supply, transport, communication and so on). The 2004 Olympic Games added to the construction and infrastructure boom. Major infrastructure projects (Athens International Airport, Athens Metro, Athens Tramway, Attica Tollway, and so forth) were promoted and completed before the beginning of the Olympic Games. The close involvement of the banking sector in funding such projects and the participation of banks and their subsidiaries in powerful business partnerships with the construction sector also served to enhance banking’s influence and bargaining power in the Greek political economy. New interest coalitions were bolstered between banks, construction companies and media groups, the latter being also run by or allied with business interests active in the construction sector.
Hit By The Crisis: The Banks’ Decline (2009–13)
The boom of the Greek banking market had followed a broader trend of financial development and expansion in the EU. However, Greece’s performance had lagged behind other EU member states, exhibiting relatively conservative credit policy stances and a limited integration of the Greek banking system with international financial markets. This relative ‘underdevelopment’, including the lack of exposure of Greek banks to ‘toxic’ products, proved beneficial during the initial phase of the ongoing financial crisis. Between 2001 and 2007, the share of total loans of credit institutions to non-credit institutions over GDP increased by 25 percentage points up to 87 per cent in 2007, while the same ratio of the EU in 2007 was 157 per cent. The south European member states’ loans to GDP ratio exceeded 110 per cent, and countries such as the UK and Ireland exhibited record levels. This relatively modest credit expansion in Greece, combined with the large volume of deposits during the previous decade (growing by an average of 12 per cent annually), contributed to a lower loans to deposits ratio compared with the other south European member states. The loans to deposits ratio of the Greek banking system rose from 48 per cent in 1997 to 80 per cent in 2007, still lower than the 2007 EU average of 115 per cent. In contrast to Greece, the loans to deposits ratio of the other south European member states exceeded by far the EU average. A downside of the feverish Greek credit expansion in 2000–7 was the lower quality of the loans: the average level of non-performing loans to total loans of that period reached 7 per cent, the highest among EU-15 member states (Nkusu Reference Nkusu2011). However, the lower quality of the banking market’s loan portfolio was offset by higher provisions. The average coverage ratio (percentage of non-performing loans covered by provisions) reached 52 per cent during 2000–7. Moreover, the Greek banking sector had one of the highest equity to assets ratios in the euro area and a capital adequacy ratio consistently over 12.5 per cent. Thus the Greek banking system found itself fairly well prepared to face the 2008–9 global financial shock after the collapse of Lehman Brothers compared with many other EU banking systems (Bank of Greece 2002a, 2003a, 2004a, 2005a, 2006a, 2007a, 2008a; Hardouvelis Reference Hardouvelis2008).
For these reasons, there was a significant time lag before the Greek economy and financial system were affected by the global crisis, where most of the EU was affected more quickly. Under the protective umbrella of a strong euro, and with limited exposure to export markets, Greece was initially shielded. But the Dubai sovereign debt default of November 2009 made global markets queasy about unsustainable public debt levels. Greece became the obvious target and the first euro area sovereign to be affected. Thus the global financial crisis morphed into a Greek and a euro area sovereign debt crisis that negatively affected the European banking market (Brender et al. Reference Brender, Pisani and Gagna2012; Popov and van Horen Reference Popov and Van Horen2013). Under a common currency the financial shock (which in the case of Greece was actually a combined fiscal and balance of payments crisis) took the form of a credit crisis instead of a currency crisis.
Although they were less exposed to ‘toxic’ products and risky financial strategies, Greek banks were affected by the drying up of liquidity in the interbank market. However, the relatively conservative operation of credit institutions, the limited integration with the European financial market, sufficient levels of capital adequacy, and the small size of the capital and money market of a bank-based financial system, allowed the Greek banking sector to withstand the initial phase of the crisis better than other European economies.
Via tightening bank finance, the liquidity shortage of the interbank market was transmitted to the ‘real’ economy. The shortage of interbank market liquidity deteriorated through the mass capital outflows, as foreign institutional investors fled to safe havens. Along with the financial system, the crisis affected the economic sectors whose activity mostly relied on bank credit. In the period that followed the 2008 credit crunch, and even more so after the conditionality programmes of austerity that came with Greece’s resort to an EU/International Monetary Fund-sponsored bailout in April 2010, credit to all sectors of the economy collapsed and the economy was mired in steep recession. By the end of 2012, the Greek economy had lost over one-fifth of its pre-2008 GDP. By that time, the banking sector was struggling.
In sum, after 2009, the Greek banking sector was specifically affected by the combined effects of:
1 The exclusion from international financial markets and the interbank market as a result of successive waves of credit downgrading. As a consequence, the Greek banking system had to resort to extraordinary financing from the European Central Bank and subsequently (given the lack of adequate quality collateral) to the expensive Emergency Liquidity Assistance (ELA) mechanism of the Bank οf Greece under the euro system.
2 The extensive deposit outflows. Between December 2009 and June 2012, total deposits of domestic residents were reduced by about 35 per cent (from €245 billion to €158 billion); following the June 2012 elections this trend was reversed and total deposits increased until March 2013 by €22 billion or 14 per cent (Bank of Greece data 2009–13).
3 The steep recession multiplying the number of non-performing loans, and the adverse economic environment resulting in a quality decline of the banks’ asset portfolio, largely composed of Greek government bonds. Between October 2009 and early June 2012, the Greek stock market followed a downward path and the FTSE/ATHEX-CSE Banking Index lost 1,883.32 points or a staggering 94.2 per cent. This decline was steeper than the reduction of the ATHEX Composite Share Price Index. Furthermore, between December 2009 and September 2012, non-performing loans to total loans of the Greek banking market increased by around 15 percentage points (from 7.7 per cent to 22.5 per cent). The gross credit loss projections (CLPs) over the June 2011 to December 2014 period for credit riskFootnote 2 for the Greek banking market were estimated at around €47 billion (Bank of Greece 2012a).
4 The subsequent 50 per cent haircut on bank-held sovereign bonds under the voluntary restructuring of the Greek sovereign debt (private sector involvement – PSI). Implemented in April 2012, it amounted to a net present value loss of over 70 per cent on the sovereign debt holdings of domestic banks.
The restructuring of the sovereign debt in March 2012 led to gross private sector involvement losses of €37.7 billion for the total banking market. The resulting capital needs for all Greek commercial banks (taking also into account the stricter capital adequacy needs, the credit loss projections and the potential costs of future restructuring) were estimated in May 2012 at €40.5 billion, of which €27.5 billion corresponded to the four big ‘core’ banks (Bank of Greece 2012a). To cover these needs, the banks were recapitalized with money (up to €50 billion) lent to the Greek government by the euro area. One of the four ‘core’ banks failed to attract adequate private investors and came under public control. The rest remained under private management but with a sizeable public sector ownership share.
Thus the crisis ended in the reversal not only of the growing profitability trend that had lasted until 2008 but also of the privatization trend that had unfolded since the 1990s. Although the Greek banks benefited hugely from the financial bonanza of the post-liberalization and European Monetary Union credit boom years until 2008, the reasons for their post-2009 crisis were principally associated with the public sector’s over-indebtedness. Moreover, the Greek case study points out that at times of acute macroeconomic crisis (fiscal crisis, real economy and balance of payments crisis) even relatively healthy and well-capitalized banks cannot escape the confines of their sovereign. The euro area crisis has demonstrated that no banking sector can be healthier than its sovereign.
In sum, in the Greek case, successive contagion processes unfolded. In the initial phase, the 2008 global financial crisis affected the Greek economy to a mild degree, given its limited trade openness and very limited exposure of domestic credit institutions to ‘toxic’ products and high-risk wholesale banking (Pagoulatos and Quaglia Reference Pagoulatos and Quaglia2013). Subsequently, however, the recession that started mildly in 2008 before deepening during the years that followed, began to affect the banks by raising the number of non-performing loans. The 2010 sovereign debt crisis and austerity policies rapidly damaged the banks’ balance sheets through the channels of exposure to ‘country risk’, government bonds and the real economy. Thus the sovereign crisis turned into a banking crisis. Then, in 2012, the banking crisis was turned back into a sovereign problem, as the recapitalization cost burdened the public debt. Throughout this process, both the sovereign and banking crises collaborated in driving liquidity and capital away from the Greek market, leading to exorbitant credit costs for even healthy domestic enterprises, with market interest rates of 7–10 per cent compared with 2 per cent levels for their competitors in the AAA euro area countries. Thus the lack of sufficient institutions and instruments for stabilization in a deficient architecture for monetary union, in an environment of financial liberalization, collaborated in accentuating procyclicality, both in the cheap-credit boom period until 2008 and in the credit crunch post-crisis period of 2010–13.
Conclusion
Up to the early 1990s, Greece was a case of a state-directed, bank-based or credit-based financial system, as part of a post-war model of developmental finance. Then, into the 1990s, in the European single market framework, financial and credit liberalization was implemented. Unlike market-based systems, credit liberalization in Greece did not result from the coherent pressure of the banking sector, which was weak and mostly government-controlled. Banking and financial liberalization in Greece was mainly state-driven and was part of the effort to comply with the European single financial market programme. Crucially, liberalization served the Greek central bank’s agenda for a more effective use of monetary policy towards disinflation. However, in the new liberalized environment of the 1990s, the banking system began to acquire formidable power.
This was a version of structural power: it was not a matter of consolidated elite status since banking elites were relative newcomers. It was a case of structural power, resulting from the position of banking capital in a bank-based financial system, an opening and rapidly growing economy, experiencing a stock market boom (as an emerging market on the road to accession to the European Economic and Monetary Union in the late 1990s) and one of the most rapid rates of credit expansion in the euro area until 2008, given the low starting point of mortgage and consumer credit. This credit boom of the period up to 2008 was not only beneficial for the bankers, multiplying banking sector profits and incomes; it also conveniently served the government’s political objectives by delivering rapid and widespread growth and prosperity, driven by cheap credit. In a bank-based and liberalized financial system, operating within an economic ‘model’ of debt-driven growth, the banking sector was bound to emerge as a powerful player. The banking sector’s function of financing the boom of the Greek economy until 2008, its position in the specific structure of the Greek economy, was a crucial defining factor of its structural power – so too was the convergence of its interests with those of the government.
Under the European Monetary Union, without the necessary stabilizing instruments and institutions of a proper economic union, without even adequate mechanisms of consolidated financial sector supervision, financial excesses were bound to prevail, both in the cheap-credit boom and in the credit-crunch bust part of the cycle. The euro regime transformed the currency risk into credit risk, without really abolishing the balance of payments constraint. When the balance of payments crisis occurred, even healthy private sector borrowers could not access finance, as cross-border investors voted with their feet, and capital fled the country. Even a healthy, well-capitalized and powerful banking sector that had reaped great profits in the pre-crisis period could not escape the confines of its sovereign. In as much as Greek financial liberalization was not the work of the bankers’ influence, despite proving tremendously beneficial for them, so the demise of the banking sector was not primarily the result of their own omissions but mostly of the fiscal failure of the sovereign and of the current account imbalances accumulated in the euro area.
The Greek banking sector expanded drastically following financial liberalization, and especially under the single currency. Profitability grew and the bankers evolved into a superbly powerful interest group in Greek economic and political life. Such a rise in power was a reflection of the surrounding political economy, an unmistakable version of structural power in a regime of unfettered capital mobility, in a bank-based national financial system, amidst a cheap-credit driven growth conjuncture, to boot. This was a conjuncture which was exacerbated by the structural deficiencies of the euro area that translated accumulating external surpluses of the core euro area economies into copious capital inflows to the deficit economies of the periphery. A global capital glut up until 2008 transformed the domestic financial and banking system into the gatekeeper of finance, power and wealth. That was despite the fact that the Greek banking system remained among the most relatively conservative in the euro area, the private debt stock relatively low by EU standards, and banking involvement in high-risk wholesale markets and toxic products almost negligible. When the crisis hit, however, after 2010, the earlier vigour and strong capitalization of the banking sector was not sufficient to release it from the vicious doom-loop that tied domestic banks to their national government.
The case study also serves to redirect our attention to the crucial importance of the nation state, at a time of acute global financial crisis. Banks are cross-border when they flourish under liberalization, but they become national again in sickness and death, as they suffer the economic and fiscal decline of their sovereign. What was a case of bank power before the crisis, by 2012 had evolved into one of bank powerlessness. Eventually, a liberalized and internationalized banking system finds itself trapped inside a sovereign trapped inside a supranational, European and global financial order. Faced with that international context, a small integrated economy operates as a policy receiver and to a significant extent a price taker for its financial asset values. Such was the case with the exogenously driven financial liberalization, as well as in the terms that surrounded the bailout conditions and which defined the outcomes for the post-crisis Greek banking system.
Acknowledgements
The paper has benefited from the helpful comments of the workshop convenors Michael Moran and Anthony Payne, and the excellent research assistance of Christos Triantopoulos.
