Fight between ECB, EU gov?ts over Greece gets dirty (Update)

The European Central Bank (ECB) has raised the stakes in its bid to prevent a restructuring of Greek debt by telling euro zone governments it would refuse to accept Greek bonds as collateral if they approved such a move.

Greek banks rely on the system of collateral to fund themselves and refusing to accept government bonds as security would effectively cripple them.

The warning came from ECB Executive Board member Juergen Stark on Wednesday after ECB President Jean-Claude Trichet had made a similar threat at a eurogroup meeting in Brussels on Monday.

ECB officials have warned for weeks that a debt restructuring would have catastrophic consequences for the euro zone and stepped up their rhetoric this week after Eurogroup Chairman Jean-Claude Juncker suggested the bloc was open to a voluntary extension of Greek debt maturities.

“For the ECB, according to our statutory obligations, a debt restructuring would undermine the collateral adequacy of Greek government bonds,» Stark said.

“This means that a debt restructuring would make the continuation of large parts of central bank liquidity provision to the banking system of Greece impossible.”

The ECB has warned repeatedly about the knock-on effects of restructuring and its members have been equally dismissive of the idea of a «reprofiling» in which private creditors would be asked to exchange their bonds voluntarily for paper with longer maturities.

Economists said, however, that no matter how opposed to a restructuring the ECB is, the central bank would ultimately have trouble cracking down on collateral because the consequences for Greece and the broader single currency bloc could be disastrous.

“Let’s assume we get a situation where Greek banks at short notice have to replace all their collateral,» Gilles Moec, an economist at Deutsche Bank, told Reuters. «The seizure that would follow for the Greek banking system would have consequences for the rest of Europe.”

“I think this is all part of the negotiation process. Deep down the ECB probably knows something has to happen, but they want it to be as mild as possible.”

Experts also expressed doubts, however, about whether the Frankfurt-based central bank would follow through on the threat, and described it as a negotiating ploy designed to halt the momentum toward some form of restructuring.

The Royal Bank of Scotland said on Thursday that the ECB could still accept collateral from Greek banks for loans in the event the nation restructures debt, contrary to suggestions by Stark.

According to ECB rules, any decision on whether to accept Greek government bonds as collateral from the nation?s banks to obtain ECB funding seems to be ?largely discretionary and there is no automatic legal constraint,? Jacques Cailloux, chief euro-region economist for RBS in London, said.

The ECB ?seems to have been increasingly sidelined from the political debate surrounding the debt crisis over the last few months,? Cailloux said.

The ECB is concerned that allowing Greece to renege on some of its obligations would create similar expectations for other indebted euro-area nations such as Portugal and Ireland, which followed Greece in accepting aid.

The ECB has bought 76 billion euros of bonds of fiscally stressed countries in the past year and may suffer along with private investors in a restructuring.

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