BOE Policy Makers Say They May Reassess Rate-Cut Case: Economy

Bank of England policy makers may reconsider the case for an interest-rate cut after assessing the impact of new lending and liquidity measures as Europe’s debt crisis keeps pressure on them to do more to stoke growth.

The Monetary Policy Committee said while the arguments for and against cutting the benchmark rate from the current record low of 0.5 percent hadn’t changed since June, they may be reviewed in the coming months, according to the minutes of its July 4-5 meeting. The MPC voted 7-2 to increase quantitative easing by 50 billion pounds ($78 billion) to 375 billion pounds at the meeting.

The Bank of England has joined counterparts around the world in expanding measures to support growth as the threat from the euro-area turmoil increases. The Bank of Japan has opened the door to buying debt with negative returns, and Federal Reserve Chairman Ben S. Bernanke said yesterday the Fed may take further action to boost the recovery.

“Central banks are looking to add to their options for further easing and reevaluate all the tools at their disposal,” said Chris Scicluna, an economist at Daiwa Capital Markets Europe in London. “With the exception of Japan, the outlook has deteriorated markedly across the major economies, and there may be further weakness in the euro area going into the end of the year.”

The pound extended its decline against the dollar after the minutes were published. It fell 0.3 percent to $1.5600 as of 2:02 p.m. in London. Money-market traders added to bets on lower Bank of England interest rates, pricing in a 25 basis-point cut as soon as April, according to so-called Sonia rates.
‘Compelling’

The Bank of England’s decision to expand QE in July came two months after officials stopped expanding stimulus.

Most U.K. central bank officials felt that the case for more stimulus was “compelling and stronger than at the previous meeting,” the minutes said. “There were increasing signs that the threat of a disorderly resolution of the financial tensions in the euro area was affecting growth at home.”

In addition to QE, the Bank of England has started a “Funding for Lending Scheme” to boost credit and recommended that banks be allowed to tap liquidity buffers to ease credit strains. It said in the minutes that the impact of these measures was “potentially significant, but hard to calibrate.”
Rate Assessment

At the July 4-5 meeting, the MPC was unanimous in a decision to leave its benchmark rate unchanged. While it said cutting the rate had “drawbacks” compared with more QE and the arguments for and against such a move were the same as in June, this assessment could change.

“The impact of the FLS and other policy initiatives might, in time, alter the committee’s assessment of the effectiveness of such a rate reduction,” the minutes said. “The committee could review this option again when the impact of the FLS and other policy initiatives was more readily apparent; that was unlikely to be for several months.”

Data today showed U.K. unemployment fell to a nine-month low in the quarter through May as the London Olympics helped to create jobs. The jobless rate based on International Labor Organization methods fell to 8.1 percent from 8.2 percent in the period through April. Jobless-benefit claims rose 6,100 in June. The increase, though larger than the 5,000 median forecast in a Bloomberg News Survey, was inflated by a benefit-rule change that took effect May 21.
BOJ Purchases

Separately today, the Bank of Japan (8301) scrapped a 0.1 percent yield floor for government bond purchases and removed the limit on purchases of securities with maturities of one year or less in its so-called rinban operation.

The central bank is struggling to buy enough bonds to execute a stimulus program to strengthen the economy as Europe’s crisis and a global economic slowdown boost demand for the government’s debt. It tweaked its stimulus program on July 12 without adding extra money and said that it would buy more treasury bills. The overnight rate target stayed at between zero and 0.1 percent, unchanged since October 2010.

The BOJ failed to attract enough bids in its rinban purchases on July 6 for a second time since May, as banks chose to hang on to the bonds rather than take cash. A six-month funding operation also didn’t reach its bid goal for a 14th straight time on July 10.

“It didn’t look good for the BOJ to have a series of failures in their operations given they have been saying they are pursuing powerful monetary easing,” said Mari Iwashita, a bond strategist at SMBC Nikko Securities Inc. in Tokyo. “Negative yields is an indication of their determination.”
China House Prices

Elsewhere in Asia today, China reported that new home prices rose in 25 of 70 major cities in June from May, indicating that economic growth may be supported by a rebound in the real-estate market.

In the U.S., Bernanke will testify before Congress for a second day. Policy makers “are looking for ways to address the weakness in the economy should more action be needed to promote a sustained recovery in the labor market,” he said yesterday.

The Fed’s Beige Book assessment of economic conditions is also due today. The residential property market may be one of the bright spots, with a Commerce Department report likely to show that builders began work on more houses in June than at any time since October 2008, according to a Bloomberg News survey.

At the Bank of England, policy makers Spencer Dale and Ben Broadbent dissented from the majority this month in favor of no change to the bond-purchase target, saying bank-credit measures may offset the need for more stimulus via QE.

The central bank said 2012 growth would be “roughly flat” and it was also “less likely” inflation expectations would become ingrained in the economy. Data yesterday showed U.K. inflation unexpectedly slowed to 2.4 percent in June, moving closer to the central bank’s 2 percent target.

The minutes “suggest a range of future policy possibilities, although all of them in an easier direction,” said David Tinsley, an economist at BNP Paribas in London. In November, the MPC “could decide to boost plain vanilla QE by another 50 billion pounds. But if there are signs the funding for lending scheme is gaining some traction they could instead lean more in the direction of a cut in bank rate.”
 

Special Report: Clandestine loans were used to fortify Greek bank

The chairman of one of Greece's largest banks and his family took out loans totaling more than 100 million euros to finance an undisclosed stake in the bank, according to audit documents seen by Reuters.

Offshore companies owned by Michael Sallas and his two children paid for shares in the Piraeus Bank, the country's fourth-biggest, by borrowing money from a rival bank.

Together the shares make the Sallas family the largest shareholder in Piraeus, with a combined stake of over 6 percent. The purchase of these shares has not been declared to the Athens stock exchange by Piraeus.

The loans to Sallas, who was executive chairman of Piraeus Bank until last month and remains its non-executive chairman, raise new questions about the stability and supervision of the Greek financial system at a time when European taxpayers and the International Monetary Fund are bailing out its banks with more than 30 billion euros.

The IMF had no comment on the issue, and a spokesman for the Bank of Greece declined to comment on Sallas's holdings in Piraeus, citing banking confidentiality guidelines. "Our supervision department cannot comment on specific prudential data available or actions taken with regard to any specific bank as such information is confidential," he said.

According to audit reports seen by Reuters, most of the money borrowed by companies linked to Sallas was used to buy shares in a Piraeus Bank rights issue in January 2011. The issue was designed to strengthen Piraeus's capital base.

The disclosure highlights concerns that Greek banks have been borrowing money from each other and using it to meet recapitalization requirements, but not making that clear.

"This (the Greek financial system) is a closed circuit, operating as a system of power with no transparency and effective supervision," said Louka Katseli, professor of economics at the University of Athens and former Greek minister of economy. "Through triangle deals between banks, businessmen and other banks, capitalization requirements were fulfilled without new money injected."

Piraeus Bank and Sallas declined to answer specific questions for this story, but offered an interview later this month. On Sunday Sallas issued a statement to the Greek media attacking Reuters and accusing the news agency of "slandering" and "undermining" the bank.

"It is not the first time that I or Piraeus Bank have been the target of attacks," the statement said. "What should be of concern to all of us in the present situation is the safety and the further strengthening of our banking system."

Reuters Global Editor for Ethics and Standards Alix M. Freedman said: "Our coverage of Piraeus and of the Greek banking system has been accurate and fair to every person and institution involved."

In April, a Reuters investigation found that Piraeus had failed to tell shareholders it had rented expensive properties from a network of private companies run by the Sallas family. The bank has sued Reuters for defamation over the story, claiming 50 million euros in damages.

Reuters has also reported allegations of mismanagement at the Proton Bank and at a Cyprus-based bank formerly known as the Marfin Popular Bank that operates in Greece. Proton's former president and major shareholder, Lavrentis Lavrentiadis, has vigorously denied allegations that he used the bank to loan himself and associates hundreds of millions of euros.

Andreas Vgenopoulos, former chairman of Marfin Popular Bank, now renamed Cyprus Popular Bank, has denied conflicts of interest alleged by a Greek parliamentary inquiry and Cypriot lawmakers.

It was Marfin's largest then Greek subsidiary, the Marfin-Egnatia Bank (MEB), that issued the loans to the Sallas family. According to two audit reports on Marfin, the loans were ranked among its riskiest exposures, judged both by their shortfall in collateral, which is mainly Piraeus shares, and risk of future losses to the bank.

The two audit reports, from January and May this year, were shown to Reuters by separate and unconnected sources. They were authenticated in interviews with banking sources and officials in Greece and Cyprus.

Internal Marfin auditors said executives at MEB had "failed to act in the best interests of the bank" by granting successive loans to Sallas to buy his own bank shares. By 2011 his investment in those shares, the auditors found, had "dire prospects" and had been made through special purpose vehicles and with no personal guarantees.

The auditors wrote: "Worth noting is that loan approval took place at a time when it was all but clear that the outlook for the Greek banking sector and by extension for Piraeus stock was deeply negative." The loans were issued "when our Bank was already in a precarious liquidity situation".

SHARE PURCHASES

According to the records, Sallas first obtained a loan agreement from MEB in May 2009. A facility for up to 150 million euros was signed off by the Marfin group's Vgenopoulos, then executive vice-chairman. A spokesman for Vgenopoulos and Efthymios Bouloutas, the bank's chief executive at the time, declined to comment on the loans due to "banking secrecy legal obligations."

By January last year, according to the first audit report, MEB loans to Sallas companies amounted to 48 million euros. But that month, "another 65 million was used" to purchase shares in Piraeus's 800-million-euro rights issue.

The Sallas family bought their shares via three separate Cyprus-based companies, according to both audit reports. The purchase brought the family's total loans to 113 million euros, secured on collateral estimated to be worth less than 30 million euros, based on Piraeus's recent share price.

The three Cyprus-based companies are Shent Enterprises, which is owned by Sallas and which has 45 million euros in outstanding loans to MEB; Benidver Enterprises, which has 22 million in loans; and KAEO Enterprises, which has 46 million in loans.

Records at Cyprus' corporate registry show that both Benidver and KAEO were owned by Michael Sallas personally until a month before Piraeus's rights issue.

Ownership was switched to two Greek companies linked to the family and in turn owned by a single Cyprus company called Avecmac, whose shareholders are anonymous. But MEB audit documents from 2012 seen by Reuters record Benidver as owned by Sallas' daughter Myrto and KAEO as owned by Sallas' son George.

Avecmac, contacted through its representative in Cyprus, did not respond to requests for comment. Myrto Sallas declined to comment; George Sallas could not be reached.

FAMILY HOLDINGS

Exactly how many shares Sallas and his family bought in Piraeus last January, and in whose name they were registered, is not clear.

Some indication comes from the number of Piraeus shares pledged by the Sallas companies as collateral for the loans. Those rose by 62 million after the rights issue, bringing the total number of Piraeus shares pledged as collateral to more than 66 million, or around 6 percent of ordinary stock in the bank.

In filings to the stock exchange and in other declarations, Sallas has said he owns around 16 million shares in his name, as well as a total of around 16 million purchased through Shent Enterprises. He has declared no share purchases by his children.

Under Greek and European law, any holding in a public company of more than 5 per cent should be announced publicly. Greek law also requires all company executives "and persons closely associated with them" to make all share transactions public.

Marfin's auditors, according to their report, regard loans to Sallas and his family as "connected."

But Kostas Botopoulos, chairman of Greece's Capital Market Commission, which regulates the country's public companies, said the decision of who to define as a "person closely associated" was "considered on an ad hoc basis." There is no specific ruling on whether a spouse or children would fall in that category, he said.

Piraeus Bank released a statement saying the bank would not answer the detailed questions sent to Sallas and the bank due to "civil and criminal cases" between Piraeus and Reuters, and between the bank and a former Piraeus employee "charged with serious crimes." Piraeus has previously said the former employee had defamed the bank.

"The Bank will refute the allegations in court," the statement said. "To do otherwise would clearly be in contempt of the proceedings. In the interest of transparency, to defend its reputation and reassure its shareholders, the Bank has provided the Bank of Greece with all the relevant information."

CAPITAL BASE

The loans to investors in the Piraeus rights issue highlight a bigger concern in the Greek banking sector. Piraeus issued more shares last year to strengthen its capital base, enabling it to score higher in European bank stress tests.

The successful issue, Sallas said at the time, showed "a sign of confidence in Piraeus Bank, the Greek banking system and of course the prospects of the Greek economy."

But Sallas did not make public the loans he and other shareholders had taken out to help make the rights issue a success.

In all, according to loans disclosed so far, nearly one-fifth of the new capital in Piraeus was raised with financing from other Greek banks - including another 20 million euros or so loaned by MEB to investors, and 70 million euros loaned by the Proton Bank. The Proton loans went through offshore companies in tax havens such as the Cayman Islands.

Proton has since been nationalized after Greece's money-laundering authority alleged fraud and embezzlement in cases unrelated to Piraeus or MEB.

According to several European banking and accounting experts, if banks loan money to finance major stakes in other banks, then the industry's regulator, in this case the Bank of Greece, should deduct the same amount from the capital the lending bank claims to hold.

Dr Peter Hahn, a fellow at London's Cass Business School and an adviser to the UK Financial Services Authority, said that a loan scheme whose only means of repayment was shares in another bank should, under international rules, be treated as if the lending bank was directly purchasing shares in the other bank. "The equity in the lending bank would otherwise be supporting risk of loss in both banks," he said.

Hans-Peter Burghof, a professor of banking and finance at the University of Hohenheim, Germany, said that billions of euros had been given to the Greek banking system without adequate supervision of the sector. "It's our money and it has been given without controls. It's a disaster," he said.

If banks lent to finance each other's shares, he said, then "this way you can produce as much equity as you like and make banks as big as you like. It is not real equity." He likened it to "a kind of Ponzi scheme."

Burghof said that, whether deemed to be covered by regulations or not, if bank equity was raised in this way, the banks and companies involved should be treated as a consolidated whole. "If the regulator finds out (about loans from one bank to finance share purchases in another), he should discount this equity," he said.

The European Banking Authority, which is meant to safeguard the stability of the financial system and transparency of markets, generally agreed with that analysis, though a spokeswoman said there may be exceptions in the case, say, of a "financial assistance operation".

There is no indication in their financial statements that either Proton or Marfin made deductions in their capital levels after their loans for Piraeus shares.

In a statement the Bank of Greece said it does not ordinarily require capital deductions from banks that lend money for the purchase of shares in other unconnected banks.

"European Union law does not prohibit granting loans to an entity (person or organization) in order to participate in a share capital increase of another credit institution," the bank said. Such a deduction from regulatory capital would only take place if a bank granted loans to buy its own shares, it said.

It added that the disclosure of major stakes (over 5%) in a public company was "indeed a requirement on the stakeholder". But this was policed by the Capital Market Commission, not the Bank of Greece.

The CMC said that shareholders, in calculating whether they hold 5% or more, should aggregate holdings if they have an agreement to act together.
 

Goldman Sachs Cuts Pay as Revenue Drops to Lowest Since 2005

Goldman Sachs Group Inc. (GS) cut jobs and money to pay employees and will seek $500 million in additional cost reductions this year after first-half revenue fell to the lowest since 2005.

Compensation, which includes salaries, benefits, bonuses and the expense of deferred pay awarded in prior years, dropped 14 percent to $7.29 billion in the first six months, the New York-based bank said today in a statement. Revenue in the same period dropped 14 percent to $16.6 billion.

Lloyd C. Blankfein, 57, has cut 1,000 jobs this year to counter the slowest first-half since before he became chairman and chief executive officer in mid-2006. Trading, which contributed about 60 percent of the bank’s revenue in 2011, dropped 6 percent in the first half from a year earlier. Blankfein said last month he thinks the slowdown is a temporary reaction to the financial crisis.

“We’re very cognizant of the returns our shareholders get versus what our employees get,” Chief Financial Officer David Viniar said on a conference call with analysts. Compensation will probably be the primary target for additional cost reductions, he said. The bank will add junior employees and will try to strike a balance to avoid losing talent, he said.

“If we cut our comp very dramatically in one year, it would help our returns, but we live in a competitive environment,” he said. “We still have people leaving for multiyear offers” from rival banks and other financial firms.
Average Employee Pay

The first-half compensation expense, at 44 percent of revenue, is enough to pay each of Goldman Sachs’s 32,300 employees $225,789 for the first six months of the year. The firm set aside $8.44 billion a year earlier, which was 44 percent of revenue and equal to an average $237,662 for each of the 35,500 people employed by Goldman Sachs at the time.

The last time Goldman Sachs generated less revenue in the first half was 2005, when the company made $11.2 billion, according to company reports. The firm, which reported it had about 21,800 full-time employees at the end of the fiscal first half in 2005, began including consultants and temporary staff in its employment numbers in 2009. The firm is the fifth- biggest U.S. bank by assets.

JPMorgan Chase & Co. (JPM), the largest U.S. lender, cut first- half compensation expenses at its investment bank 16 percent to $4.91 billion, or 35 percent of revenue. That would be enough to pay each of the 26,553 workers in the unit an average of $184,989 for the period.

In the first half of 2011, JPMorgan allocated $5.86 billion for compensation in the unit, or 38 percent of revenue. That was enough to pay an average $211,358 for each of the 27,716 employees at the time.

Figures for average pay don’t represent what any employee actually receives and are calculated by dividing the total compensation expense by the number of employees.
 

HSBC Probe Results in Promises Regulator, Bank Will Clean Up Act

HSBC Holdings Plc (HSBA) executives apologized for opening their U.S. affiliate to a river of Mexican drug lords’ cash, and the U.S. regulator that failed to stem the flow vowed to prevent a repeat.

“I deeply regret we did not act sooner and more decisively,” Comptroller of the Currency Thomas Curry said at a day-long hearing yesterday of the Senate Permanent Subcommittee on Investigations. He said his agency, which regulates HSBC’s U.S. arm, is partially responsible for letting Europe’s largest bank give terrorists, drug cartels and criminals access to the U.S. financial system and will take “a much more aggressive posture.”

Calling the Office of the Comptroller of the Currency a “lapdog not a watchdog,” Senator Tom Coburn of Oklahoma, the senior Republican on the panel, accused the agency of seeing weaknesses in the bank’s money-laundering safeguards and being “at a loss” to act. Curry, who took office in April, said the OCC will step in when a bank accumulates deficiencies, and has changed its policy to count repeated compliance failures against a bank’s safety-and-soundness rating.

Six current and former executives of London-based HSBC displayed a united front of contrition at the hearing, with compliance chief David Bagley announcing in front of the senators that he will step down from his post. Bagley said his bank “has fallen short of our own expectations.” HSBC shares dropped 1.7 percent to 547.40 pence in London trading yesterday, limiting its gains this year to 11.5 percent.
Risk ‘Sinkhole’

“Some international banks abuse their U.S. access,” said Senator Carl Levin, the Michigan Democrat who heads the subcommittee, saying these transgressions were bad enough to warrant a reconsideration of the bank’s charter. “The end result is that the U.S. affiliate can become a sinkhole of risk for an entire network of bank affiliates and their clients around the world playing fast and loose with U.S. rules.”

Senate investigators focused on New York-based HSBC Bank USA NA as a “nexus” for U.S. dollar services and transfers. Coburn pointed out that HSBC isn’t alone and that “similar problems exist at other banks.”

Paul Thurston, head of HSBC’s retail banking and wealth management unit and former chief of the Mexico unit, said the company is closing the unit’s U.S. dollar accounts in the Cayman Islands, a jurisdiction that Levin said is “known for secrecy and money laundering.”

HSBC bolstered its presence in Mexico in 2002 by buying the nation’s fifth-largest bank, Grupo Financiero Bital SA, better known as Bital. Senate investigators found that Bital had a history of deficiencies in anti-money-laundering controls. Thurston described the business side in the Mexican bank “overriding” its compliance side.
335-Page Report

From 2000 to 2009, HSBC gave its lowest risk rating to Mexico despite “overwhelming information” that it posed a high risk for drug trafficking and money laundering, investigators wrote in a 335-page report accompanied by 529 pages of HSBC e- mails and other documents. Mexican clients included casas de cambio, or currency-exchange firms, which U.S. authorities say often launder money.

Wells Fargo & Co. (WFC)’s Wachovia Bank unit paid $160 million in 2010 to resolve a criminal probe that cartels were using such exchange houses to launder cash.

HSBC’s Mexican bank shipped $7 billion in bulk cash to the firm’s U.S. bank in 2007 and 2008, leaving U.S. and Mexican authorities concerned cartels were the source, the report said.

In 2007, the head of Latin America compliance sent an e- mail to a colleague condemning the Mexican affiliate for “rubber-stamping unacceptable risks,” according to the report.

“What is this, the School of Low Expectations Banking?” the executive, John Root, wrote in the e-mail.
Exit Interview

Leopoldo Barroso, a former HSBC anti-money-laundering director, told company officials in an exit interview that he was concerned about “allegations of 60 percent to 70 percent of laundered proceeds in Mexico” going to affiliates, investigators wrote.

In 2008, the Mexican unit carried a years-old backlog of 3,659 accounts meant to be closed, according to a 2008 e-mail from Warren Leaming, who was an HSBC legal adviser. He said 675 of those accounts were suspected of money-laundering activity.

Some of HSBC’s alleged dealings with state sponsors of terror and Mexican drug dealers were reported in July 2005 by Bloomberg Markets magazine, which documented bank ties to Iran, Libya, Sudan and Syria.

HSBC’s U.S. unit “offers a gateway for terrorists to gain access to U.S. dollars and the U.S. financial system,” according to the subcommittee’s report.
Links Ignored

The lender ignored links to terrorist financing among its customer banks, including Riyadh, Saudi Arabia-based Al Rajhi Bank (RJHI), which had ties to terror groups through its owners, the report said. Mohammad Al Yami, an Al Rajhi spokesman, didn’t respond to an e-mail requesting comment.

The report also cited HSBC’s violations of Treasury Department sanctions on dealings with Iran. The U.S. is seeking to isolate Iran from the global banking system through sanctions enforced by the Office of Foreign Assets Control, or OFAC.

HSBC executives discussed those sanctions in e-mails cited in the report. Bagley wrote after the Sept. 11, 2001 terror attacks that the bank should pay attention to proposed legislation to extend U.S. reach over foreign banks, “particularly if we are unfortunate enough to process a payment which turns out to be connected to terrorism.”

He wrote: “Some of the routes traditionally used to avoid the impact of U.S. OFAC sanctions may no longer be acceptable.”
Iranian Transactions

An outside audit by Deloitte LLP showed that 25,000 transactions totaling more than $19.4 billion involved Iran, according to the report. Of those, as many as 90 percent passed through the bank’s U.S. accounts with no disclosure of ties to Iran, the report shows. Senate investigators documented similar transactions involving North Korea, Cuba, Sudan and Burma.

Bank documents also showed HSBC’s U.S. unit cleared transactions through at least six Iranian banks.

Since 2009, the U.S. Justice Department entered deferred- prosecutions agreements with six banks over OFAC violations, including ING Groep NV (ING), Barclays Plc (BARC), ABN Amro Holding NV, Credit Suisse Group AG (CSGN) and Lloyds Banking Group Plc. (LLOY) Most violations involved stripping information from wire-transfer documentation to hide the role of a banned person or country.

HSBC has said that it’s cooperating with investigations by the Justice Department and other agencies into possible Iran sanctions violations. It’s also cooperating in unrelated probes by the Justice Department and Internal Revenue Service into whether it helped Americans evade taxes through HSBC India.
 

Europe's debt markets not working: Spain economy minister

Europe's debt markets are not functioning properly due to the slow and complicated decision-making process in the euro zone, Spain's Economy Minister was quoted as saying in an interview with Spanish daily La Vanguardia.

"There are no (debt) operations between nations in the monetary union and practically the only demand for Italian debt comes from Italians," Luis de Guindos said.

"A similar thing is happening in France and Spain."

The minister added that investors outside the euro zone had no confidence in the euro.

"This renationalization of the capital markets is very negative," he said.

Spain's borrowing costs are likely to stay high on Tuesday when it tests investor appetite for its debt for the first time since announcing more austerity last week, suggesting markets remain unconvinced it can avoid a European bailout.

The euro zone had better fiscal fundamentals than the United States, Britain and Japan, meaning the real problem was an internal one, de Guindos said.

"There is a problem from the point of view of the fundamentals of the monetary union," de Guindos said.

"The decision-making process in the euro zone is slow and complicated. That is where international investors who highlight the weak points attack, at the moment Italy or Spain, at another moment, it will be others."
 

Special Report: Clandestine loans were used to fortify Greek bank

The chairman of one of Greece's largest banks and his family took out loans totaling more than 100 million euros to finance an undisclosed stake in the bank, according to audit documents seen by Reuters.

Offshore companies owned by Michael Sallas and his two children paid for shares in the Piraeus Bank, the country's fourth-biggest, by borrowing money from a rival bank.

Together the shares make the Sallas family the largest shareholder in Piraeus, with a combined stake of over 6 percent. The purchase of these shares has not been declared to the Athens stock exchange by Piraeus.

The loans to Sallas, who was executive chairman of Piraeus Bank until last month and remains its non-executive chairman, raise new questions about the stability and supervision of the Greek financial system at a time when European taxpayers and the International Monetary Fund are bailing out its banks with more than 30 billion euros.

The IMF had no comment on the issue, and a spokesman for the Bank of Greece declined to comment on Sallas's holdings in Piraeus, citing banking confidentiality guidelines. "Our supervision department cannot comment on specific prudential data available or actions taken with regard to any specific bank as such information is confidential," he said.

According to audit reports seen by Reuters, most of the money borrowed by companies linked to Sallas was used to buy shares in a Piraeus Bank rights issue in January 2011. The issue was designed to strengthen Piraeus's capital base.

The disclosure highlights concerns that Greek banks have been borrowing money from each other and using it to meet recapitalization requirements, but not making that clear.

"This (the Greek financial system) is a closed circuit, operating as a system of power with no transparency and effective supervision," said Louka Katseli, professor of economics at the University of Athens and former Greek minister of economy. "Through triangle deals between banks, businessmen and other banks, capitalization requirements were fulfilled without new money injected."

Piraeus Bank and Sallas declined to answer specific questions for this story, but offered an interview later this month. On Sunday Sallas issued a statement to the Greek media attacking Reuters and accusing the news agency of "slandering" and "undermining" the bank.

"It is not the first time that I or Piraeus Bank have been the target of attacks," the statement said. "What should be of concern to all of us in the present situation is the safety and the further strengthening of our banking system."

Reuters Global Editor for Ethics and Standards Alix M. Freedman said: "Our coverage of Piraeus and of the Greek banking system has been accurate and fair to every person and institution involved."

In April, a Reuters investigation found that Piraeus had failed to tell shareholders it had rented expensive properties from a network of private companies run by the Sallas family. The bank has sued Reuters for defamation over the story, claiming 50 million euros in damages.

Reuters has also reported allegations of mismanagement at the Proton Bank and at a Cyprus-based bank formerly known as the Marfin Popular Bank that operates in Greece. Proton's former president and major shareholder, Lavrentis Lavrentiadis, has vigorously denied allegations that he used the bank to loan himself and associates hundreds of millions of euros.

Andreas Vgenopoulos, former chairman of Marfin Popular Bank, now renamed Cyprus Popular Bank, has denied conflicts of interest alleged by a Greek parliamentary inquiry and Cypriot lawmakers.

It was Marfin's largest then Greek subsidiary, the Marfin-Egnatia Bank (MEB), that issued the loans to the Sallas family. According to two audit reports on Marfin, the loans were ranked among its riskiest exposures, judged both by their shortfall in collateral, which is mainly Piraeus shares, and risk of future losses to the bank.

The two audit reports, from January and May this year, were shown to Reuters by separate and unconnected sources. They were authenticated in interviews with banking sources and officials in Greece and Cyprus.

Internal Marfin auditors said executives at MEB had "failed to act in the best interests of the bank" by granting successive loans to Sallas to buy his own bank shares. By 2011 his investment in those shares, the auditors found, had "dire prospects" and had been made through special purpose vehicles and with no personal guarantees.

The auditors wrote: "Worth noting is that loan approval took place at a time when it was all but clear that the outlook for the Greek banking sector and by extension for Piraeus stock was deeply negative." The loans were issued "when our Bank was already in a precarious liquidity situation".

SHARE PURCHASES

According to the records, Sallas first obtained a loan agreement from MEB in May 2009. A facility for up to 150 million euros was signed off by the Marfin group's Vgenopoulos, then executive vice-chairman. A spokesman for Vgenopoulos and Efthymios Bouloutas, the bank's chief executive at the time, declined to comment on the loans due to "banking secrecy legal obligations."

By January last year, according to the first audit report, MEB loans to Sallas companies amounted to 48 million euros. But that month, "another 65 million was used" to purchase shares in Piraeus's 800-million-euro rights issue.

The Sallas family bought their shares via three separate Cyprus-based companies, according to both audit reports. The purchase brought the family's total loans to 113 million euros, secured on collateral estimated to be worth less than 30 million euros, based on Piraeus's recent share price.

The three Cyprus-based companies are Shent Enterprises, which is owned by Sallas and which has 45 million euros in outstanding loans to MEB; Benidver Enterprises, which has 22 million in loans; and KAEO Enterprises, which has 46 million in loans.

Records at Cyprus' corporate registry show that both Benidver and KAEO were owned by Michael Sallas personally until a month before Piraeus's rights issue.

Ownership was switched to two Greek companies linked to the family and in turn owned by a single Cyprus company called Avecmac, whose shareholders are anonymous. But MEB audit documents from 2012 seen by Reuters record Benidver as owned by Sallas' daughter Myrto and KAEO as owned by Sallas' son George.

Avecmac, contacted through its representative in Cyprus, did not respond to requests for comment. Myrto Sallas declined to comment; George Sallas could not be reached.

FAMILY HOLDINGS

Exactly how many shares Sallas and his family bought in Piraeus last January, and in whose name they were registered, is not clear.

Some indication comes from the number of Piraeus shares pledged by the Sallas companies as collateral for the loans. Those rose by 62 million after the rights issue, bringing the total number of Piraeus shares pledged as collateral to more than 66 million, or around 6 percent of ordinary stock in the bank.

In filings to the stock exchange and in other declarations, Sallas has said he owns around 16 million shares in his name, as well as a total of around 16 million purchased through Shent Enterprises. He has declared no share purchases by his children.

Under Greek and European law, any holding in a public company of more than 5 per cent should be announced publicly. Greek law also requires all company executives "and persons closely associated with them" to make all share transactions public.

Marfin's auditors, according to their report, regard loans to Sallas and his family as "connected."

But Kostas Botopoulos, chairman of Greece's Capital Market Commission, which regulates the country's public companies, said the decision of who to define as a "person closely associated" was "considered on an ad hoc basis." There is no specific ruling on whether a spouse or children would fall in that category, he said.

Piraeus Bank released a statement saying the bank would not answer the detailed questions sent to Sallas and the bank due to "civil and criminal cases" between Piraeus and Reuters, and between the bank and a former Piraeus employee "charged with serious crimes." Piraeus has previously said the former employee had defamed the bank.

"The Bank will refute the allegations in court," the statement said. "To do otherwise would clearly be in contempt of the proceedings. In the interest of transparency, to defend its reputation and reassure its shareholders, the Bank has provided the Bank of Greece with all the relevant information."

CAPITAL BASE

The loans to investors in the Piraeus rights issue highlight a bigger concern in the Greek banking sector. Piraeus issued more shares last year to strengthen its capital base, enabling it to score higher in European bank stress tests.

The successful issue, Sallas said at the time, showed "a sign of confidence in Piraeus Bank, the Greek banking system and of course the prospects of the Greek economy."

But Sallas did not make public the loans he and other shareholders had taken out to help make the rights issue a success.

In all, according to loans disclosed so far, nearly one-fifth of the new capital in Piraeus was raised with financing from other Greek banks - including another 20 million euros or so loaned by MEB to investors, and 70 million euros loaned by the Proton Bank. The Proton loans went through offshore companies in tax havens such as the Cayman Islands.

Proton has since been nationalized after Greece's money-laundering authority alleged fraud and embezzlement in cases unrelated to Piraeus or MEB.

According to several European banking and accounting experts, if banks loan money to finance major stakes in other banks, then the industry's regulator, in this case the Bank of Greece, should deduct the same amount from the capital the lending bank claims to hold.

Dr Peter Hahn, a fellow at London's Cass Business School and an adviser to the UK Financial Services Authority, said that a loan scheme whose only means of repayment was shares in another bank should, under international rules, be treated as if the lending bank was directly purchasing shares in the other bank. "The equity in the lending bank would otherwise be supporting risk of loss in both banks," he said.

Hans-Peter Burghof, a professor of banking and finance at the University of Hohenheim, Germany, said that billions of euros had been given to the Greek banking system without adequate supervision of the sector. "It's our money and it has been given without controls. It's a disaster," he said.

If banks lent to finance each other's shares, he said, then "this way you can produce as much equity as you like and make banks as big as you like. It is not real equity." He likened it to "a kind of Ponzi scheme."

Burghof said that, whether deemed to be covered by regulations or not, if bank equity was raised in this way, the banks and companies involved should be treated as a consolidated whole. "If the regulator finds out (about loans from one bank to finance share purchases in another), he should discount this equity," he said.

The European Banking Authority, which is meant to safeguard the stability of the financial system and transparency of markets, generally agreed with that analysis, though a spokeswoman said there may be exceptions in the case, say, of a "financial assistance operation".

There is no indication in their financial statements that either Proton or Marfin made deductions in their capital levels after their loans for Piraeus shares.

In a statement the Bank of Greece said it does not ordinarily require capital deductions from banks that lend money for the purchase of shares in other unconnected banks.

"European Union law does not prohibit granting loans to an entity (person or organization) in order to participate in a share capital increase of another credit institution," the bank said. Such a deduction from regulatory capital would only take place if a bank granted loans to buy its own shares, it said.

It added that the disclosure of major stakes (over 5%) in a public company was "indeed a requirement on the stakeholder". But this was policed by the Capital Market Commission, not the Bank of Greece.

The CMC said that shareholders, in calculating whether they hold 5% or more, should aggregate holdings if they have an agreement to act together.