Greek banking system on rocks as funds dry up

As Greece and its creditors make a final attempt to agree a new bailout, time is running desperately short for that country’s banking system.

There now appears no prospect of any of the banks opening this week and the future of some may quickly come under threat, unless the European Central Bank can be persuaded to release additional funds.

And the problem is that the ECB is likely to need to see signs of political progress to do so, otherwise fearing it is stepping in to finance what are effectively insolvent banks.

This means any short term financing deals to carry Greece over the coming months needs to address a way to release funding for the banking system before a longer term solution is agreed as part of a multi-year deal.

The political talks may drag on, but all the signs are that the Greek banks are simply running out of cash. The ECB has kept the emergency cash it supplies, via the Bank of Greece, at about €89 billion. But as money continues to seep out of Greek banks, despite strict limits on deposits, at least some banks may be close to collapse.

If the ECB is to ease the strain, as the political talking continues, it may look for some commitment or a wider political agreement on funding the Greek state in the coming months.

Given the financial difficulties facing the Greek state, the ECB announced on Monday it would tighten the rules in terms of its acceptance of collateral from the Greek banks as security for loans. Basically, if the solvency of the Greek state is in question, then the bonds which the Greek banks give to the ECB as security have a higher risk attached.

Means of exchange

Significant wider damage is being done to the Greek economy by the closure of the banks, with consumer demand crashing and businesses laying off staff. Such is the strain that either some way will be found to free some ECB cash, or Greece is going to have to start issuing new means of exchange to keep some basic activity going,

There has been speculation that the Greek government could be forced to issue IOUs to meet its liabilities in terms of pensions, public sector wages and other social payments. These would effectively be a promise to pay at a future period – a commitment which could only be met if Greece actually eventually agrees a bailout plan.

In theory, IOUs could circulate alongside euro – California issued IOUs briefly in 2009 when its was trying to sort out its budget. But the practical implications of this kind of parallel currency in Greece would be difficult, particularly given the uncertainty about whether the IOUs could ever be repaid.

In time, with no new deal, Greece would have to bite the bullet and introduce some kind of fully fledged new currency. However there are huge practical complications here too and significant losses in the purchasing power of Greek people and the value of their savings, as the new currency would fall sharply against the euro.

Inside or outside the euro, the job of restoring the Greek banking system is enormous. It looks likely that given the renewed weakness in the economy at least some of the banks will also need new capital, as well as liquidity. Depositors will fear that some of their savings will be taken to help recapitalise the banks, as happened in Cyprus in 2013. If Greece does crash out of the euro, one immediate issue will be what happens to its liabilities to the European Central Banking System, via the Bank of Greece.

In the short time, though,the problem is the financial system has ground to a halt – and the longer it continues, the worse it will get. As Greece and its creditors talk about a new deal, this is a crunch issue.