Greek banks are set to re-open next week, after weeks of staying shuttered as capital controls took effect to prevent more money from leaving Greece.

That’s a good start. A bailout unlocking fresh funds for Greece may also be on the table soon - pending tortuous talks. The bailout deal foresees a 25-billion euro capitalization of Greek banks. But serious reform would have to address the banking sector’s bloated scale - although opinions differ on how that might be approached.

A European official who asked not to be named told Reuters on July 9 that it's likely that Greece’s four big banks - National Bank of Greece, Eurobank, Piraeus and Alpha Bank will have to be reduced or merged to form two - a measure Athens is expected to resist.

"The Greek economy is in ruins. That means the banks need a restart," the official said.

Another said the savings made by reducing the number of banks may not be worth the pushback the corresponding loss of jobs would create. There's also concern about too few banks leading to over-concentration of market power.

“If the argument is cost efficiency and whether Greece is overbanked, with four players there is a semblance of competition,” said a senior Greek banker. “With fewer players, competition will be reduced even more.”

Too many banks

Overbanking is a problem that isn't unique to Greece. Studies on how Europe is overbanked abound. The European Systemic Risk Board published a much cited-paper last year.

The paper’s premise was that the European banking sector was too big relative to its overall economy, and that it wasn’t contributing much to growth at all. In addition, the banks tended to emphasize trading among each other and financial markets, while leaving its role of financing the real economy – the one that deals with the actual production of trade and services – behind.

In addition – overbanking is naturally associated with risk. The paper says:

“…large banking systems may be associated with excessive risk taking by banks: as systems become very large, banks may become “too large to save” by domestic taxpayers, thereby increasing the likelihood of sovereign and financial crises.”

It’s a nice tie-in back to Greece, and what sort of changes might happen to the banking sector would happen post bailout. Would recapitalizing a smaller banking sector help?

When Cyprus received a bailout to the tune of 10 billion euros in March 2013, one of the conditions was that the Bank of Cyprus has to take over the island nation’s second largest bank, Laiki, and make up for capital shortfall by raiding deposits – a “bail-in”.

Whether Greece will have to shut down some its banks after stress tests this year remains to be seen. A Greek bail-in, however, has been repeatedly dismissed by the country’s authorities.

jd/nz (Reuters, DPA)