With ECB gun to its head, Greek saga can’t go on much longer

Greece is due to repay the International Monetary Fund €1.5 billion by June 30th. But it faces an even more immediate pressure – it’s banks could run out of money if the government does not quickly do a deal with its creditors. This is now the immediate pressure on the Greek government. As we know from our own recent economic history, pressure on the financial system can quickly force decisions, and the the European Central Bank (ECB) is a key player in how it all pans out.

At Thursday’s fractious meeting of eurogroup finance ministers, the ECB warned that, as things stand, there was no guarantee the Greek banks could open on Monday.

Depositors have been withdrawing cash, fearing that the the Greek government might be forced – at some stage – to put a levy on savings, as happened in Cyprus, or that Greek euro zone exit may lead to big losses as their savings are redenominated into a currency which is worth much less.

Emergency call

The ECB agreed in an emergency phone call of council members on Friday to extend more of its cash to make up the resulting shortfall. But such is the pace at which cash is being pulled out – rumoured to be €1 billion plus a day – that this is just a temporary measure.Greece is close to having to impose capital controls, which work by limiting bank withdrawals and foreign transfers of cash.

It is not clear how long the ECB will continue to extend more and more cash, most of which is coming from its Emergency Liquidity Assistance programme. Under its rules it cannot fund banks which it does not believe are solvent. And if it believes the Greek government is heading towards default, then it may say its rules forbid it extending emergency liquidity to the banks – whose solvency is underpinned by holdings of Greek government debt – or mean it must do so on less advantageous terms.

The question heading into Monday’s eurogroup leaders’ summit is,if there is no progress, will the ECB continue to extend more and more cash to the Greek banks? Or will we immediately see capital controls to stop the banks from collapsing?

Capital controls

Unless this is resolved quickly, bank outflows are likely to force capital controls very soon. Savers will fear first that the EU finance ministers and the ECB might try to push a “ Cyprus” solution – in 2013 depositors in some Cypriot banks lost a large chunk of their savings, as part of a plan to recapitalise the banks. Worse,a Grexit would see the Greek central bank recapitalise banks with a new, less valuable currency, and redenominate savings into this “new drachma” leading to a big hit on the real value of what savers held.

The ECB is now a key player in the drama. In September 2008, the ECB insisted that no bank in Ireland be allowed to fail, a number of witnesses have told the banking inquiry, and this was a factor in introducing the guarantee. However the current Greek situation is more analogous to the period leading up to the bailout, when the ECB system had some €140 billion extended to the Irish banks to prop them up , as international cash poured out. At that stage the ECB threatened to withdraw emergency liquidity, which accounted for a large portion of this money, unless we signed up for the bailout. Now, Greece has the ECB gun to its head and is facing a bank run in a late and dangerous phase. This really can’t go on much longer.