Banks had to resort to central bank funding, at first through Eurosystem monetary policy operations, but gradually, due to the lack of eligible collateral, to emergency liquidity assistance from the Bank of Greece, at a higher cost. Following the PSI last year, banks took huge one-off losses on their bond portfolios.
At the same time, the recession led to a continuous increase in non-performing loans. What started out as a liquidity problem threatened to turn into a solvency problem. The twin crises generated negative feedback loops, creating a general crisis of confidence, compounding the problems faced by the banking system, and exacerbating the contraction in GDP.