Open Society Economist Georgi Angelov: Greek Banks' Units in Bulgaria Delicious Bite

Interview with Georgi Angelov, Senior Economist at the Open Society Institute Sofia

The prospect of a Greek default has loomed for a year and a half as the economy has been stuck in recession. Will Europe allow Greece to default?

Over the last two years Europe believed that Greece should be rescued at all costs. The proponents of the idea argued that this would cut short any lingering doubts about the future stability of the euro zone. Quite the contrary happened. Greece was aware Europe would seek to rescue it at all costs and had no incentives to implement reforms. After all why should it feel obliged to do that, if Western Europe is ready and willing to foot the bill?

The delay in implementing reforms plunged the Greek economy into a further decline, drove away investors, and eroded trust in the country. Thus the possibility of Greece failing to avert bankruptcy popped up on the agenda once again. Europe however was once again merciful on Greece – it decided to slice as much as 100 billion euros off Greece's debt burden and promised new financing to support its reforms. Many European leaders took a huge political risk and embraced the unpopular rescue plan. Europe's generosity was unprecedented, but the Greek politicians were unwilling to face the music and bear responsibility for the reforms. The surprise idea of a Greek referendum on the European rescue plan just illustrated that reluctance.

That was the last straw. Small wonder – if Germany decides to hold a referendum, Greece won't get a penny. If Greek politicians try to shirk responsibility by holding a referendum, the Germans can also do that and then Greece is doomed.

The truth is that Greece put itself on this path – nobody trusts the country any more. From now on there are two scenarios that can unfold – Greece will either implement the required reforms and clear up its act to be a true European country, or it will be expelled from Europe and become a third world country. Nobody in Europe is willing to make any more compromises. Besides should Greece be expelled from the euro zone and the EU, it can be used as an example for the other problematic countries. Greece's expulsion is no longer an anathema, but is even considered to have a healing impact. The Greeks should realize that they no longer have the right to make mistakes.

How do you expect the crisis to develop?

It is already clear that the Greek politicians are not as stupid as they seem. They pretty quickly understood Europe's message and decided to opt for an interim government and early elections. Voters now will have to decide whether to back the reforms or doom Greece to isolation and poverty. Let's hope that the reasonable people will take the upper hand.

If the Greek citizens support the reforms and the Greek politicians show political courage and responsibility, the country has a chance to achieve stability and economic growth. If this does not happen, Greece will be kicked out of the European Union. This is absolutely clear, the Greeks know what they are facing and this knowledge has a sobering effect.

The future of the other troubled countries is directly linked to the future of Greece. If the EU fails to deal with the problems of small Greece, it will certainly fail with larger countries such as Spain and Italy. That is why Greece is so important - it is a litmus test about whether the EU can solve its problems. If the EU and the euro want to play a global role, they must show determination in solving their own problems. Otherwise, the EU will fall apart and nobody in the world would consider Europe a major world power. It is not just the future of Greece or Italy, which is at stake here, but Europe's survival. Therefore we need tough measures and no compromises with the budget discipline and the reforms.

Being subsidiaries of foreign banks, the banks in Bulgaria are directly linked to the well-being of mother companies. A year ago banking experts said that was not a problem as the parent companies came from euro zone countries, they were well-capitalized and willing to support the local entities. This explanation sounds like an illusion today, does not it?

In fact, Western banks were hit very early on in the global financial crisis - most Western countries had to bail out banks, including Germany, Britain, Denmark, Belgium, etc. In Ireland, the rescue of the banks was so expensive that the whole country went bankrupt. Many Western banks still rely on governmental aid in their respective countries.

Despite speculations that Eastern Europe is a problem for banks, in fact, the banking systems of most countries in the region survived without big problems the last three years of crisis. Moreover, the bankruptcy of Irish banks did not affect their subsidiaries in Eastern Europe. For example, in Bulgaria there was a subsidiary of an Irish bank, but it did not go bankrupt when the parent bank in Ireland did. The Irish bank unit here was sold to a new owner, who invested additional capital and thus the banking system became more stable.

It has been long ago since the banks in Eastern Europe stopped being directly linked to the well-being of mother companies.

Local units are registered under local law, governed by the local central banks, have capital and liquidity aligned with local regulations. That is why the Irish bank in Bulgaria survived, although its mother company in Ireland had problems.

It is important to point out that Ireland is an exception - most Western banks are happy to have offices in Eastern Europe because of the region's economic potential, its stable and even profitable banking systems. Nobody wants to be deprived of this potential and will do so only in extreme cases.

Which are the local units that are likely to receive less support? What is the risk of bankruptcies?

It is important that the Bulgarian banks do not need support from abroad and are doing fairly well on their own. With high capital and profit levels in the banking system, there is little risk of a systemic problem. We see that banks in Bulgaria continue to attract new capital, which indicates that funding for them have not been cut off - on the contrary, they even manage to strengthen their capital position.

In the event of debt restructuring, Greek banks will require a significant recapitalisation. Which are the possible scenarios that may unfold in this case? Should Bulgaria be wary that the rules on bank recapitalisation will allow regional subsidiaries to be drained of money and put its economy at risk?

The Greek government can use up the firepower of the euro zone's bailout vehicle to strengthen the capital of its banks. Some Greek banks resorted to mergers and attracted Arab investors, which also strengthened their capital base. Greek banks will do everything they can to shun the sale of their subsidiaries in Bulgaria – they value the local market potential and do not want to lose it.

But if the Greek banks are forced to shed their assets here, there are other investors who will be happy to buy them. They are a delicious bite. Nobody will benefit if they are destroyed, on the contrary, many are interested in them because of their business potential.

If the state is forced to intervene to prop up the subsidiaries, do you think the International Monetary Fund should back the governments with financial aid?

Bulgarian banks have a BGN 10 B capital and substantial liquid assets – besides their capital and liquid assets are constantly increasing thanks to bank profits and the attraction ?f new capital from shareholders. In addition, we have a fund that serves as a deposit guarantee, which next year swell to nearly BGN 2 B. BNB also has several billion that could be used if necessary, and the government may use as a last resort about BGN 5 B from the fiscal reserve. In this sense Bulgaria can manage the situation on its own even if it deteriorates and the IMF is an unlikely option. Conversely, most neighboring countries are already working with the IMF - not only Greece but also Romania, Serbia and Macedonia have agreements with the IMF. So the IMF is already there and helps. The problem is that if a country reaches the point when it have to turn to IMF, this only shows that it has made many big mistakes.

Do you expect the biggest western lenders in Bulgaria and the Balkans to withdraw or they will continue to see the emerging market here as attractive and will be reluctant to give up space?

Everything depends on the economic policy of each particular country. Emerging markets are usually considered attractive because of their potential, but in order to increase the investors' interest the country needs to be considered as stable and reformist, and to offer potential for growth. This is something that politicians should be held accountable for. They should not just wash their hands rattling off gloomy figures about the crisis in Europe, but assume seriously their obligations, make their countries more attractive for investments and remove obstacles to economic development.

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