By George Georgiopoulos
ATHENS (Reuters) - The recapitalisation of Greek banks must not dilute existing shareholdings too heavily or it could endanger efforts to regain the investor confidence essential to economic recovery, the chairman of Greece's third-largest lender said.
The capital needs of Greece's top four banks -- National Bank (AT:NBGr), Piraeus (AT:BOPr), Eurobank (AT:EURBr) and Alpha (AT:ACBr) -- are being assessed in a health check by the European Central Bank (ECB), with its asset quality review and stress test expected to be completed by the end of October.
Banking insiders estimate that the ECB could identify a capital shortfall of up to 15 billion euros (£10 billion), but Eurobank Chairman Nick Karamouzis told Reuters that the shareholders should not bear all the pain from day one.
"It is very important to restore trust, but existing shareholders must not be wiped out. This would significantly narrow the group of investors willing to participate in the capital boost," he said.
Greece's 86 billion euro bailout includes a 25 billion euro backstop facility to cover potential capital shortfalls of viable banks and resolution costs of non-viable ones. But the more private investor money that can be raised from U.S. hedge funds, private equity firms and other specialist investors, the less of Greece's bailout money will be needed.
RESCUE FUND
Karamouzis said that a sensible approach would be for private investors to cover part of the required capital increase, with the rest plugged by the Hellenic Financial Stability Fund (HFSF), Greece's bank rescue fund.
The baseline scenario for the ECB health check envisages the Greek economy contracting by 2.3 percent this year and 1.3 percent in 2016, followed by 2.7 percent growth in 2017.
However, better than expected economic growth of 1.1 percent in the first six months of this year suggests that gross domestic product will have to decline sharply in the second half for the baseline projection of a 2.3 percent contraction to be confirmed.
The ECB will also consider an adverse scenario, which could also be used for its shortfall calculation.
That scenario's assumptions have not been published, but Karamouzis said: "Given that the adverse scenario encapsulates extreme conditions, this capital should be in a form that does not dilute existing shareholders from day one but allows dilution to occur over time, only if and when actual capital needs materialise.
"The recapitalisation exercise should fully convince international markets and depositors of banks' financial strength, minimising the burden on Greek taxpayers and maximising private investor participation in the equity raising."
As agreed with Greece's international lenders, the recapitalisation framework will aim to ensure that banks are privately managed and facilitate private strategic investments.
DEPOSITS
Athens wants to conclude the capital boost before the end of the year to allow discretionary use of European Union rules on bank failures -- the Bank Recovery and Resolution Directive -- that limit the burden on taxpayers to avoid penalising uninsured depositors.
Karamouzis, who said that Merril Lynch, HSBC (L:HSBA) and Mediobanca (MI:MDBI) are advising on Eurobank's recapitalisation, believes that renewed political stability, restored trust in banks and the lifting of capital controls will lead to a much-needed return of deposits into the banking system.
He said that a significant proportion of the 40 billion euros that has flowed out of the banks since November could return over the next 18 months.
"An uplift to the Greek banking system's credibility could lead to a significant return of deposits, which could near 35-40 billion euros in the next 18 months," he said.
Regaining the trust of markets and depositors, reducing eurosystem borrowing of about 120 billion euros, or 65 percent of gross domestic product, and closing a funding gap of more than 100 billion euros between loans and deposits are prerequisites to restore banks' ability to fund the economy, Karamouzis said.
($1 = 0.8839 euros)