Editor’s note – this article was authored on Friday based on a Goldman Sachs note from that date. The news is moving very quickly but we still feel the content is relevant and for the most part most of the news is irrelevant – as we are focusing on quantitative and not macro guessing.

The tough talk on all sides regarding Greece’s debt program with the ECB recently has led to major haircut in the Greek banks. The Greek banking sector is under tremendous pressure right now as the uncertainty about the future weighs on investors. Analysts point to the increasing odds of capital controls or even a Grexit, which would be a huge blow to the sector, in the near future unless the ECB and the new Greek government come to some type of compromise regarding restructuring Greece’s massive debt.

A February 6th report from Goldman Sachs Equity Research offers some valuable insights into the situation, but warns that shares of Greek banks are likely to remain volatile for some weeks until the dust settles on this matter.

Goldman Sachs analysts Pawel Diedzic and colleagues note: “They expect Greece to remain in the Euro area although only after a period of potentially intense political tension. The risk of an economic and financial accident has increased, in our view, given the more confrontational stance of the new government.”

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Expect more volatility

The first point the report makes is that shares in Greek banks shares have been volatile following the recent elections (a 41% drop was followed by a 50%+ rally), with concerns about politics and liquidity fueling the swings. They believe that “…stocks are likely to stay volatile as long as the political situation is fluid.”

Greek banks dependent on European support

Greek Banks

Diedzic et al. also highlight that usage of the ECB’s facility was €56 billion as of December 31, an increase from €45 billion in November, but well off the peak of €158 billion in February 2012. They note that the ECB’s call to suspend the waiver allowing Greek bonds to be used as collateral in the ECB’s main refinancing operation combined with deposit outflows will lead to Greek banks using more of the expensive emergency liquidity assistance (ELA). However, the Greek banking sector having to become more reliant on the ELA not surprising, especially given the expiration of the eligibility of Pillar II bonds.

Greek Banks

Finally, the GS analysts note that history suggests the ECB will probably be generous in its liquidity provision relating to the ELA. They point out if the ECB takes a hard line, it will “have severely negative implications for banks, in our view.”  However, the analysts also say they “…do not foresee the ECB acting unilaterally and expect it will follow political decisions taken by Euro area states.”