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The European Central Bank on Wednesday night reminded the new radical anti-austerity government in Athens where real power in the eurozone resides.
The ECB’s decision to restrict Greek banks’ access to cheap cash was a warning shot to Greece and to eurozone leaders. The message was clear: the Syriza-led government should think again about its threat to abandon its international bailout when it expires on February 28 and agree a new deal with eurogroup finance ministers as soon as possible. If it does not, the fate of the country’s banking system — and ultimately its membership of the euro — hangs in the balance.
So how come the ECB has so much leverage?
It is all about the ECB’s collateral policy — the rules on which assets lenders can exchange for the central bank’s cash.
Since the financial crisis began, the ECB has allowed the banks to borrow as much cash as they like — through so-called open market operations — and at increasingly cheaper rates. At the moment the main refinancing rate is just 0.05 per cent.
To make sure the ECB is covered if a bank goes bust, any institution that wants to borrow must park collateral at the central bank until the loan matures.
How has the ECB changed the rules?
The rules on what the ECB accepts as collateral for its regular open-market operations have been tinkered with time and again since the crisis began. As Karl Whelan, a professor of economics at University College Dublin, writes, there is clearly an element of politics in what the ECB decides to accept.
An ECB waiver allowing junk-rated bonds to be used in exchange for euros was set to expire on February 28 if the Syriza-led government carried out its threat to leave its EU bailout programme.
That waiver will now expire on February 11, days before a crucial meeting of the eurogroup.
The ECB said the early suspension was “in line with existing eurosystem rules, since it is currently not possible to assume a successful conclusion of the programme review”. In plain English: Syriza has threatened to exit the bailout programme, so we are calling their bluff.
So why would new collateral rules matter so much to the Greek government?
First, you need to look at how this decision affects the country’s banks.
By the end of last year, Greek banks had borrowed about €56bn from the ECB. The ECB will not say how much of these loans were backed by the bonds that were banned on Wednesday night, but it could be as much as €50bn.
After the ban, Greek lenders have a choice: stump up new collateral after February 11 or pay the ECB back.
And if they cannot stump up new collateral?
It is unlikely they will be able to do so as soon as next week. But that does not necessarily create an immediate funding problem. Rather than borrow from the ECB, they can borrow from their central bank, the Bank of Greece, through what is known as Emergency Liquidity Assistance.
Lenders have to be considered solvent to be eligible. But the exact terms and conditions for ELA are shrouded in even more secrecy than those of the ECB’s regular operations. So much so that Richard Barwell, economist at Royal Bank of Scotland, compares the ELA with the rules of Fight Club.
The terms of the emergency loans are largely at the discretion of the national central bank taking on the risk. The assumption is that the Bank of Greece will continue to accept Greek government bonds and government-backed bank debt in exchange for ELA.
Having to go through ELA will probably make borrowing more expensive for the Greek banks. But, unless Wednesday’s collateral restrictions spark a run on their deposits, it should not create an immediate funding crisis. The Bank of Greece will be able to offer up to €59.5bn in ELA from February 11.
So Greece and its banks can just rely on their national central bank?
Not quite. It is the ECB that ultimately authorises ELA.
What it did on Wednesday was to tighten Greek banks’ access to normal liquidity, not cut them off. It was clearly a warning. No one expected it to move so soon.
It will undoubtedly raise questions about whether the ECB will similarly warn Greece that it will cut — or limit — ELA, which it can do with the support of two-thirds of the governing council. Its next meeting is on February 18.
Banning all Greek ELA would be a very extreme, not to mention political, step that would force Athens to impose capital controls or even exit the single currency.
So what else might the ECB do to keep up the pressure?
Greek finance minister Yanis Varoufakis’ plan to issue €10bn in short-term debt to fund the country from the end of February for three months has also met with resistance from the ECB.
Under the terms of its international bailout, Greece can issue up to €15bn in T-bills. The ECB would no doubt like Athens to stick to this limit.
If Greece carries out its threat and ditches its bailout on February 28, it is difficult to see how the ECB can stop it issuing more debt. But the ECB has ways of deterring Greece’s banks from buying it.
The banks cannot use more than €3.5bn of the T-bills issued to secure cash through either the ECB’s regular liquidity operations or ELA, leaving them susceptible to a run on their deposits.
Even if the ECB did raise the €3.5bn limit, which seems unlikely, it could use its supervisory powers to warn them against loading up on more T-bills than could be used for collateral.
Will Greek banks listen?
The low demand at Wednesday’s T-bill auction would suggest Greek banks are hearing the message loud and clear. If they don’t buy the debt, it’s difficult to see who will.