European Central Bank President Mario Draghi is convening his Governing Council on Sunday for an extraordinary meeting to discuss Greece.
After euro-area finance ministers rejected Greece’s request for an extension to its bailout package so it could hold a referendum on a bailout proposal by its creditors, Draghi and his colleagues must decide how to respond.
The key issue is Emergency Liquidity Assistance, the funds provided by the Greek central bank to the nation’s lenders to offset deposit outflows, which have mounted during five months of failed political talks. ELA stood at almost 89 billion euros ($99 billion) as of last week.
To receive the funds, banks must be solvent and have adequate collateral. Because of Greek lenders’ holdings of sovereign bonds and their reliance on state guarantees for their asset valuations, both conditions would be in doubt if the government misses debt payments to its creditors.
The Governing Council is the ECB’s decision-making body and consists of the euro area’s 19 national central-bank chiefs, including Greece’s Yannis Stournaras, plus the six members of the ECB’s Executive Board. It needs a two-thirds majority to rein in ELA. Here are some of its options.
Refusing to Expand ELA for Greek banks
The ECB could decide that some or all Greek lenders will remain solvent for a while longer and so allow them to continue to access ELA.
The country’s current bailout package runs until June 30 and the government’s debt payment to the International Monetary Fund is due the same day. However improbable, that technically leaves space for a last-minute agreement with creditors.
In practical terms, even with ELA at its current total, the government might still be forced to order bank holidays and capital controls to prevent a bank run as customers see a last chance to remove their cash.
Ending ELA for Greek banks
While the ECB’s bank-supervision arm, the Single Supervisory Mechanism, is responsible for assessing the solvency of lenders, the final decision is made by the Governing Council. Should it say Greek banks are insolvent, it would have to end ELA.
Such a decision would mean banks would be unable to provide cash to their depositors on demand. They would probably have to keep their doors shut on Monday and the Greek government would be forced to impose capital controls.
Tightening collateral requirements
While the ECB insists that the Greek central bank impose discounts on the collateral it accepts against ELA, to protect against losses, those so-called haircuts haven’t changed throughout the recent crisis.
Should the ECB decide to increase the haircuts to reflect the increased probability that banks won’t repay the cash, that would effectively limit their access to ELA and potentially lead to capital controls.
Barclays Plc calculates that banks could access another 29 billion euros of aid based on their collateral and on the assumption that current haircuts, which aren’t public, average about 48 percent. Should the haircuts be raised to 60 percent, it estimates the collateral buffer would be wiped out.
The ECB could also tighten collateral requirements by deciding that some assets are no longer eligible because of their quality.
Reducing the t-bill limit
Greek banks hold about 9 billion euros of short-term treasury bills which they typically roll over and which are critical to allowing the government to pay bills such as pensions.
While the ECB’s supervisory arm has already warned Greek banks not to increase their exposure to t-bills, the ECB could now push them to reduce their holdings to free up liquidity. The consequence would be to starve the government of funds, increasing the risk of a sovereign default and financial collapse.
Easing ELA terms
The Governing Council could ease any of the above conditions to allow banks to stay afloat in an attempt to prevent a widespread financial crisis.
Should it do so, it would attract accusations of breaking it own rules, undermining its own credibility and, in the worst case, break European Union law that bans central-bank financing of governments.