The ECB Straitjacket and Greece

by Enis May 16, 2012 11:40 am • Commentary

These types of headlines are going to dominate the rest of the trading day, so we wanted to get our quick thoughts posted.

The European Central Bank has stopped monetary policy operations with some Greek banks as they have not been successfully recapitalized, euro zone central bank sources said on Wednesday.

The ECB declined to comment.

The ECB only conducts its refinancing operations with solvent banks. With no access to ECB funds, the banks concerned must go to the Bank of Greece for emergency liquidity assistance (ELA).

It was unclear exactly how many banks were affected.

One person familiar with the matter said four Greek banks’ capital was so depleted they were operating with negative equity capital. According to its own rules, the ECB cannot provide liquidity to banks in such a situation.

The ECB said earlier on Wednesday it continued to support Greek banks.

The main issue here is that the Greek banks would have been insolvent many, many months ago if it were not for funding from the ECB.  What is the process for the ECB to fund Greece?

The ECB set up a program called the Emergency Liquidity Assistance program (ELA for short).  It provides emergency loans to banks in the peripheral countries (primarily Greece, Ireland, and Portugal) in order to prevent  a bank run from occurring.  The loans are not handed out willy nilly, however, no matter what ZeroHedge says.  The ECB has legal guidelines on how it can loan funds.  Those guidelines stipulate that all of its loans must be backed by appropriate collateral.  So when a Greek bank goes to the ELA program to ask for more money, it gives the ECB assets or loans on its own balance sheet as collateral, and the ECB gives it the funds.

This headline reads to me like the Greek banks have run out of collateral to post to the ECB.  Again, by European law, the ECB cannot just give free money to the Greek banks.  The ECB seems to be pleading with the Greek government to essentially give the Greek banks more collateral so that they can post it to the ECB, and the ECB can give the Greek banks money.  But so far, no mas.

So the Greek banks seem days or weeks away from closing their doors, given the deposit outflows that are occurring every day.  If they close their doors, it will look something like this, and maybe not just in Greece:


Update:  Here is a good article from FT Alphaville explaining the issues involved in more detail.  A fragile situation to say the least.