As talks between Greece’s new government and its euro-area partners turn confrontational, Mario Draghi may soon find himself with an unpleasant dilemma.
The European Central Bank president controls the last source of funding that euro area lenders turn to when they’ve been denied money everywhere else. Greek institutions are now clinging on to that increasingly tenuous lifeline, as deposits vanish and collateral runs short. In the event of a political breakdown, it will be the ECB that has to decide whether or not to cut it.
Greek banks, which play a key role in funding the government, lost about 11 billion euros in deposits in January, as anti-austerity party Syriza closed in on its election victory. As lenders run short of ways to plug the funding gaps, Greece’s rebellion against the terms of its bailout risks becoming a run on the banks and, ultimately, a sovereign default.
“If Europe is serious about keeping Greece in the euro zone, and if Greece is serious about staying in the euro zone, then I think the ECB can bridge the gaps and prevent financial panic from happening,” said Christian Schulz, senior European economist at Berenberg Bank in London. “If that cover isn’t there, then Mr Draghi and the ECB are in a very delicate situation.”
Money is increasingly tight. Throughout the crisis, Greece has been able to meet its obligations, even while locked out of international debt markets, by issuing short-term bills that local banks can buy and then pledge to the ECB as collateral for further funding.
The government faces a string of tests to its solvency over the next two months, like the repayment of about 2.2 billion euros ($2.5 billion) in bailout loans and interest to the International Monetary Fund, while the trusted route of rolling over treasury bills is becoming less certain.
Greek banks have already reached a 3.5-billion-euro limit on treasury bills that the ECB authorizes as collateral for loans. To make matters worse, tax revenue has slumped by more than 2 billion euros in the past two months, leaving the government more reliant than ever on the banks.
Greek banks’ eligibility for ordinary ECB cash facilities, using junk-rated Greek government bonds as collateral, has always been subject to the country being in a euro-area bailout program.
If the government sticks to its pledge not to extend the current program when it expires at the end of February, and the EU offers no alternative, the banks would be forced to replace as much as 30 billion euros in ECB funding directly from their own central bank — so-called Emergency Liquidity Assistance.
ELA, too, is in the gift of Frankfurt. The ECB will next review the Greek central bank’s emergency line on Feb. 4, and can order it to be shut off if it deems it inappropriate. The same procedure takes place every two weeks.
“There is indeed the possibility of so-called ELA,” ECB Vice President Vitor Constancio said on Saturday in Cambridge, England. “But in any case that will be ultimately a decision of the Governing Council which I cannot predict or comment on at this stage.”
An acceleration of bank deposit outflows “could lead the government to establish capital controls and raise the amount of ELA,” according to Michel Martinez, an economist at Societe Generale in Paris. If the ECB cuts the ELA funding line, “Greece will have no choice but to issue its own currency,” he wrote in a Jan. 28 note.
In the short term, the ECB could still ease the way for the Greek government. In the past, the Governing Council agreed to lift the 3.5-billion T-Bill ceiling, such as in August 2012, when a large chunk of government debt matured. The condition then was that the government was engaged in constructive negotiations with the EU creditors.
Jeroen Dijsselbloem, chair of the euro region’s group of finance ministers met with new Greek finance minister Yanis Varoufakis in Athens on Friday.
The euro area remains committed to continuing to supplying funding “during the life of the program and beyond, until it has regained market access, provided Greece fully complies with the requirements and the objectives of the program,” Dijsselbloem told reporters afterward.
For his part, Varoufakis said his government wouldn’t cooperate with the troika, which comprises officials from the European Commission, the ECB and IMF, and is the body that monitors whether the country is complying with those objectives.
If the tone of the dialog deteriorates, then the ECB is likely to tell Greek banks not to buy any further government bills now, as they’d be useless for obtaining central-bank cash. The ECB’s supervisory chief, Daniele Nouy, has already written to executives, advising them to invest their liquidity only in assets that can be used as collateral.
The first test of Greece’s continuing ability to rollover its T-bill stock will come on Feb. 4 — the same day as the ECB Governing Council meeting — when it auctions 625 million euros of 26-week notes. Non-competitive and second-day bids would normally raise the amount sold to 1 billion euros, which would refinance 947 million euros coming due at the end of the week.
Another key date is the Feb. 16 meeting of euro-area finance ministers that will discuss Greece’s program, according to analysts at Nomura including Lefteris Farmakis and Nick Matthews in a Feb. 28 note.
“The calendar is complicated further by the need of Greek banks to roll more and more T-bills as foreigners’ rollover rate decreases,” they wrote. “There is likely to be more volatility in Greek assets as the market is called to reprice the risk of an ultimate confrontation with Europe.”