Recapitalize Greek banks to prevent fear in mkts: Expert

With talks of Greece exiting the eurozone, global markets and the European markets have been volatile over the last few weeks. In an interview with CNBC-TV18, Sarah Hewin, head of research for Europe with Standard Chartered Bank speaks about the possible scenarios in Greece and Europe in the next few weeks.

It is very important to remember that if Greece were indeed to exit, there is going to be a huge challenge to the EU system itself. A lot of loans that have been very easily given on a bilateral basis to member countries and to the general pool of the EFSF will all be challenged. So, a Greek exit cannot be taken lightly at all by anyone around the world and certainly not by Europe itself.

Below is the edited transcript of the interview on CNBC-TV18. Also watch the accompanying video.

Q: Charles Goodhart, Professor of Economics at LSE was telling that the TROIKA must recapitalize Greek banks, but offer the Greek sovereign no more bailout packages. Does this look like possible? He says that it is the banks which spread contagion and fear and therefore, if the TROIKA backs the banks, the sovereign left to itself will shape up and fall in line.

A: I think it's very important that the Greek banks are recapitalized and they have enough capital. At the same time, the EU may decide that they don't want to carry on supporting the government, especially if a new government comes in, that is not committed to following the terms of the bailout program. Certainly, supporting the banking system, but not supporting the sovereign is one option.

Q: People have been quite easily talking about a Greek exit but, now with a run on one Spanish bank, do you think European markets and politicians will realize that it is not going to be easy to let Greece go?

A: This is the big concern, the worry about contagion to other countries. The EU has a firewall in place through the bailout funds, but those funds won't cover all of the costs that would be involved in supporting Spain, potentially Italy or Belgium.

That will remain a big concern and if Greece exits, then of course there is a risk that other countries may find themselves in a difficult situation. That risk arises.

Q: This week the ECB stopped dealing with some Greek banks temporarily, saying that they are not adequately capitalized. Is the ECB just pressuring the TROIKA or the EU politicians to release money to capitalize the banks?

A: The Greek banks are receiving capital to be recapitalized. That was something which was agreed with the second bailout.

I think from that aspect, the process is in place. The worry is that if we see an escalation of deposit withdrawal from the Greek banking system then there may need to be additional capitalization. And those funds may be difficult to find.

Q: Barclays bank has calculated the cost of a Greek walkout to be about 100 billion euros for the euro system. If we should count the loss only in terms of loans offered to Greece, to the EFSF and the exposure to Greek bonds, won't there be a much bigger damage in terms of the member nations itself not wanting to bailout others? Who will contribute to the EFSF if what they have contributed to Greece is lost? Is it not a danger to the existence of the EU itself?

A: This is the big risk. It's always been a question of whether credit countries are going to continue to be willing to support the debtor countries. If we see a Greek exit, then if we could guarantee that, that could be ring fenced. Nobody would be too concerned.

The risk is that you have a knock on effects that other countries run into trouble, while at the same time creditor countries are very unwilling to provide the additional finance that would be needed to support them. At that point, you see the threat of a disintegration of the Euro.

Q: Do you see Spanish and Italian yields shooting up even more in the run up to the Greek elections and therefore, do you expect the ECB will step in with some bond buying?

A: I think a lot depends on market sentiment between now and June 17. That in turn will be determined to a certain extent, by what opinion polls are saying about how Greeks are likely to vote.

If there looks to be a shift back towards pro-bailout center parties, then sentiment may improve. If on the other hand, the anti-bailout parties on the left and right continue to gain support, markets will become more nervous that there is going to be a crisis after the elections.

Q: What are you watching out for in Europe now? Are you just reading the lips of European politicians or are you watching out to Greek voters and what the polls say? Are you watching Spanish yields? What all should investors watch?

A: I think all of those factors are very important. The yields give an indication of market sentiment, but politicians give an indication of how much flexibility there is likely to be in terms of growth projects, growth plans for the Euro area.

The data of course will tell us whether the economy is in recession or whether in fact things are starting to turn around. All of these factors are going to be important.