The European Central Bank gave its backing on Monday to Greek plans for a 10 billion euro aid package to support the country's banks.
Greece intends to have a new Financial Stability Fund (FSF) in place by the end of the month to give its hard-hit banks a way of beefing up capital.
The ECB welcomes the establishment of the FSF as a means to improve the safety net for the Greek banking system during an economic downturn which could have adverse implications for the asset quality of Greek credit institutions, the ECB said in a legal opinion published on its Web site.
More bad loans, downgrades to sovereign debt holdings and a deepening recession are seen taking a heavy toll on Greek banks this year.
The new rescue fund will be in place for 7 years for banks whose capital falls below standards set by the central bank but which are unable to borrow in markets.
The ECB welcomes the FSF's role in facilitating strategic decision-making in terms of restructuring the Greek banking system and thus allowing it to continue its function in extending credit to the Greek economy, the ECB said.
Capital injections from the FSF will take place via the purchase of preferred shares banks will issue. The idea is that a stronger balance sheet will allow banks to re-access capital markets and limit recourse to Eurosystem facilities.
Banks will have up to five years to pay back the money and buy back their preferred shares at the issue price. Beyond this time limit, they will face a penalty surcharge on the buyback.
If banks cannot repurchase the preferred shares and are unable to meet capital requirements, the shares will be converted into ordinary shares, and the FSF can order a restructuring to make the bank viable.
One cautionary point from the ECB was that money deposited by the stability fund at the Bank of Greece should receive interest payments in line with market rates to avoid breaching European laws.
(Reporting by Marc Jones, additional reporting by George Georgiopoulos in Athens, editing by Stephen Nisbet)