How the uncomfortable and very possible scenario of capital controls would play out

The following scenario could become a reality if the deposit outflows from local banks continue at the same high rate as in recent days:

The governor of the Bank of Greece calls the Greek premier to inform him that capital controls are necessary to prevent the domestic banking system from collapse. Due to the outflows, the banks are just hours away from running out of cash. The Bank of Greece is updating the Ministry of Finance, the European Central Bank, the Single Supervisory Mechanism and the European Commission. The premier signs a legislative decree to immediately introduce capital controls. This act will have to be passed by Parliament at a later stage. To gain time, the Bank of Greece and the Ministry of Finance urgently request the European Commission’s approval of the temporary introduction of capital controls aimed at securing the stability of the financial sector. The European Commission approves the request, noting that the Hellenic Republic should lift the capital controls as soon as possible as they violate EU treaties.

This entire procedure has to be concluded in two hours at the most. The Bank of Greece sends detailed instructions to the banks regarding the implementation of the capital controls, the limitations and the exemptions. If there is panic, the Bank of Greece will ask banks to remain closed for some days until depositors calm down.

Back to reality

How likely is the above scenario at this time? According to Moody’s, the probability is over 51 percent, and a negative development could increase that figure sharply.

Nondas Nicolaides, a Moody’s vice president, told Kathimerini that “the Caa3 deposit ceiling for Greece and deposit rating for the four systemic banks implies a probability of default of around 51 percent within 12 months, which includes the risk of capital controls, bank holidays and any bank deposit freeze,” adding that a positive outcome to the negotiations with the creditors could decrease the risk of capital controls, provided that depositor confidence is partly restored, limiting deposit outflows. On the other hand, an unexpected negative outcome would increase the risk and the need for the imposition of capital controls to contain deposit outflows and prevent the banking system from collapsing.

There is no set formula for the introduction and implementation of capital controls, experts say. In addition, as Barclays reported last week, these are designed and adjusted based on the specific country’s particular problems. Previous capital controls in the euro area have included a cap on daily cash withdrawals from ATMs or bank branches. Limitations on remittances abroad may also be included, as well as opening new bank accounts. Fund transfers between domestic banks may be permitted, given that deposits remain within the system in this way.

Moody’s believes that the ECB will likely continue to provide the necessary liquidity to Greek banks through the ELA, as long as there is the potential for a positive outcome to the negotiations. We don’t believe that the ECB would like to serve as the catalyst for a Greek eurozone exit, and we don’t believe that it will act without the implicit consent of euro-area political leaders.