Greece and the ECB

The enforcer

How the European Central Bank can dictate terms to the Greek government

The Economist

AS PART of his campaign to present a more conciliatory face to Greece’s European creditors, Yanis Varoufakis, the new Greek finance minister, dropped by the European Central Bank (ECB) in Frankfurt on February 4th. He met Mario Draghi, its president, in an encounter Mr Varoufakis described as “fruitful”. But there are sweet fruits and bitter ones. After his visit, the ECB’s governing council served up a bitter variety by deciding to make life tougher for Greek banks, already beset by big outflows of deposits. The decision was a warning shot to the new government over its unwillingness to abide by Greece’s bail-out arrangements.

When banks borrow from the ECB, they must provide eligible collateral. As a result of this week’s decision, from February 11th Greek banks will no longer be able to present bonds that have been issued or guaranteed by the Greek government. Their ability to do so until now, in spite of the fact that junk-rated Greek debt is not strictly eligible, has rested on a waiver of the ECB’s rules. That waiver has in turn depended upon the Greek government’s compliance with the terms of a rescue undertaken by the euro area and the IMF. The ECB’s council has rescinded the waiver on the grounds that is no longer possible to assume a successful conclusion of the review of that programme.

The ECB’s decision brings forward something that would have occurred anyway at the end of February, when the bail-out programme is due to expire unless the Greek government requests an extension (something Mr Varoufakis has said it will not do). A separate decision taken a year ago would have had a similar effect on bonds issued by banks and guaranteed by the Greek government, which make up a much larger part of the collateral the banks have been using to borrow from the ECB.

The ECB’s decision means that Greek banks will soon become much more reliant upon “emergency liquidity assistance” (ELA). Normally, ECB loans are subject to risk-sharing among the euro zone’s 19 national central banks. In exceptional circumstances, however, a national central bank can lend to banks that have run out of suitable collateral, at its own risk and at higher rates of interest. This is ELA. Although national central banks can instigate its use, the ECB must be informed, and can restrict it if two-thirds of the governing council decide that is warranted.

Greek banks are therefore suffering a double blow. The uncertainty caused by elections and a change in government has prompted big deposit outflows, of €4.4 billion ($5.4 billion) in December and more than twice that in January. To make up for this, banks have had to borrow much more from the ECB. But now they have much less eligible collateral available.

The growing reliance on ELA makes the banks, and thus the Greek government vulnerable. According to Karl Whelan, an economist at University College Dublin, the ECB has great discretion over how much ELA to permit and when to withdraw it. So Greek banks’ growing dependence on ELA leaves the government at the ECB’s mercy as it tries to renegotiate its bail-out.

The ECB has form. In 2013 it announced that it would stop authorising the extension of ELA to Cypriot banks within days unless Cyprus entered a rescue programme to ensure their solvency. That forced the Cypriot government to accept a controversial bail-out programme. A threat to cut off ELA also forced Ireland into a rescue programme in 2010. Even a decision to cap ELA could have a dramatic effect, since it would be likely to trigger capital controls and limits on withdrawals from banks. Mr Varoufakis may be a specialist in game theory. Mr Draghi has had actual practice.