Greek Banking System: Greece's Achilles heel

The past six months have had a dramatic effect on the Greek banking system, having lost nearly 25% of deposits since December 2014. Confidence has evaporated, resulting in a fully-fledged bank run that led the government to impose tight capital controls immediately after the call for a referendum.

The deposits outflow has caused a dramatic worsening of banks' liquidity positions. The Eurosystem's liquidity is currently the only source of funding for Greek banks whose own liquidity needs seem to have already reached the ELA limit.

"We expect the ECB to keep the ELA ceiling unchanged until 15 July, when the Greek parliament is expected to approve a list of prior actions to unlock some financial support from Europe to avoid missing the payment to the ECB on 20 July. In case of approval, we would expect the ECB to slightly raise the ELA cap," says Barclays.

However, the tiny collateral buffer (which we estimate at c. €15bn) makes Greek banks very vulnerable to any increase in deposit outflows, should banks open again. Therefore, capital controls are expected to remain in place for a long period with the return to 'normal functioning' that would require deposit inflows. Political stability and economic improvement in addition to the agreement on a third bailout (including banks' recapitalisation) is needed to restore depositors' confidence.

Profitability and asset quality have also worsened in 2015. Despite the super-capitalisation of Greek banks under the second programme, the declining trend in the new NPLs in 2014 was reversed in Q1 15 and has almost certainly accelerated in Q2 15; a situation that is likely to require further capital injections. Recapitalisation options are likely to depend on whether Greece remains in EMU, but shareholders and creditors are at risk of losses. If banks have sufficient time (eg, as part of an agreed bail-out programme) they could look to find private solutions such as shedding assets and fresh equity raises. In the event of resolution of a bank, tools such as asset transfer/separation and bail-in of unsecured liabilities remain a big risk, although bail-in of senior unsecured debt is complicated by the fact that the EU Bank Recovery and Resolution Directive (BRRD) will not be transposed into national law until 1 January 2016.

External help may be available: Greek banks currently have between 8.5% and 11% of total 'bail-inable' liabilities (as % of total liabilities), meaning they could have access to the Single Resolution Fund (SRF) and/or the ESM, although there exist a number of conditions to accessing both funds.

Deposit bail-in risk not immaterial: While not our base case, deposit haircuts cannot be ruled out given the low stock of capital instruments and senior unsecured liabilities outstanding acting as a cushion for depositors.

If Greece leaves the EMU, it could look to print its own money in a new currency and inject capital into the banking system. 

"We estimate that the conversion rate (from euro into a new currency) of the balance sheet of the banks could be more than 70%, a rate that would have material implications for the amount of liabilities, including deposits, that too would need to be converted," added Barclays.