Draghi’s Decision

To Save or Not to Save

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Caught between a rock and a hard place.
  • Why it matters

    Why it matters

    European Central Bank President Mario Draghi holds the lifeline keeping Greece afloat and is deeply reluctant to cut it without a clear decision from Europe’s political leaders.

  • Facts

    Facts

    • The ECB on Monday night maintained its ELA to Greek banks at €89 billion, but it also tightened collateral terms.
    • Greek Prime Minister Alexis Tsipras is to present his proposals at an emergency summit of euro zone leaders on Tuesday.
    • Critics of the ECB warn that the ELA assistance to Greek banks may soon breach E.U. rules.
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    Audio

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With European leaders including German Chancellor Angela Merkel  insisting that the ball is now in Greece’s court following the people’s resounding “No” to bailout terms on Sunday, the president of the European Central Bank, Mario Draghi, finds himself in the uncomfortable position of being responsible for Greece’s immediate fate.

Like Greece, Mr. Draghi is running out of time and options. He keeps stressing that parliaments and politicians must decide on Greece’s future, but there’s no doubt that he’s a key player in this unfolding drama, with the power to kick Greece out of the euro almost overnight by shutting off its access to cash.

Greece is perhaps days away from bankruptcy. European leaders will be meeting on Tuesday to once again begin talks about whether Greece should receive a fresh bailout from its international creditors. But until they take that decision, it’s up to Mr. Draghi to decide how long he wants to keep Greece’s banks afloat.

“Without further ELA loans the Greek banks will probably have no alternative but a payment moratorium.”

Jan Pieter Krahnen, Center for Financial Studies

The Italian economist, who has been president of the Frankfurt-based ECB since 2011, is damned whatever he does. If he keeps emergency loans to the Greek banking system, accusations will grow that he’s breaking euro zone rules that prevent his bank from funding governments. If he pulls the plug, he’ll break the euro he famously vowed to protect in 2012, “whatever it takes.”

On Monday evening, the ECB kept the lifeline intact, saying it would maintain the cap on its emergency liquidity assistance for Greece at €89 billion, or $98 billion. But it also tightened the collateral terms, which made it slightly harder for banks to borrow.

The ECB has not raised its limit on these emergency loans since June 26 – that alone is what has already forced banks across the country to close their doors and issue no more than €60 per day to their customers. If the ECB were to halt the loans altogether, the banks may have to close their doors for good.

“Without further ELA loans the Greek banks will probably have no alternative but a payment moratorium,” said the head of the Frankfurt-based Center for Financial Studies, Jan Pieter Krahnen.

The Greek government too would run out of money. It could no longer pay public workers’ salaries or pensions and would probably have to introduce a replacement currency to meet its own obligations.

For obvious reasons, Mr. Draghi is deeply reluctant to shut off funding. He sees it as his duty to keep the single currency together as long as possible.

And so he drifts uncomfortably between the world of central bankers and the world of politicians. Criticism of his stance may be mounting within the ECB, but he has stressed that the bank is adhering to the rules. As long as the Greek banks are solvent, the central bank is obliged to supply them with money. Conversely, that means of course that if the banks aren’t solvent, the ECB is obliged to turn off the tap.

The solvency of the Greek banks is closely linked to the solvency of the Greek government. Financial sources said the banks hold some €25 billion in Greek government paper, of which €8 billion is in the form of T-Bills, very short-term paper. In addition, the banks have deferred tax credits amounting to 40 percent of their capital. So a government default would tear an enormous hole in their finances.

“The Greek banks have long been bankrupt,” said one financial source.

To survive, that means the banks urgently need to be recapitalized. But how? As of now, there is no pan-European fund for bailing out or winding down banks on the continent. Instead, it would be up to the Greek government and the Greek central bank to deal with a bank collapse.

The government, of course, has no money for a bailout. One option would be a so-called bail-in whereby the creditors and depositors of banks would be required to take a share of the losses. In the Cypriot financial crisis of 2012/2013, savers with deposits exceeding €100,000 had to waive up to half their claims.

But Cyprus had many foreign customers who had parked their money in its banks, making this more palatable. In Greece, most of the customers affected would be domestic businesses.

“That would amount to the destruction of the Greek economy,” said one central bank source. Central bankers therefore regard such a bail-in as unlikely in Greece’s case. Besides, there is no legal basis for such a step in Greece.

It boils down to three options for Mr. Draghi. The best option: Greek Prime Minister Alexis Tsipras presents a proposal that euro zone leaders can discuss at today’s summit – one that other Europan leaders signal they can work with. With a realistic prospect of a third bailout deal being reached, the ECB could keep the Greek banks afloat, and possibly even raise the amount of emergency loans if hands out.

The second option: There’s no deal and the euro zone leaders declare finally that there is no prospect of a third bailout. In that case Mr. Draghi would have to wind down ELA, but the government leaders would have to explicitly take public responsibility for the consequences in their joint communique, said sources in Brussels.

Third option: The leaders play for time. In that case, Mr. Draghi would likely keep ELA frozen at current levels and demand that the governments find a solution. He wouldn’t have much time, as the banks are literally running out of cash, despite their capital controls limiting withdrawals to €60 a day. Grexit would be almost impossible to prevent.

For the moment at least, the ECB doesn’t seem to have to worry about the wider fallout of the Greek crisis. Sunday’s referendum didn’t panic markets, although investors did predictably opt for safe haven assets such as German government bonds, and pulled some money out of southern European bonds. The yield on the benchmark German 10-year bond fell as low as 0.66 percent on Monday before recovering slightly later in the day.

The yield on 10-year Italian and Spanish bonds rose 10 basis points to 2.35 and 2.33 percent respectively, while Portuguese bonds climbed 0.2 points to 3.1 percent. To be sure, these countries now have to pay twice as much for their debt as they did in March, but these rates are far below the levels of around 7 percent they reached at the height of the euro zone’s debt crisis in 2011 and 2012, when many feared that “Grexit” could mean the break-up of the entire euro zone.

This time around, bank analysts don’t expect a bond sell-off in the so-called peripheral euro zone countries. Greece is now regarded as an isolated case. Bruno Cavalier, chief economist of French broker Oddo & Cie, doesn’t see a risk of contagion whereby a Greek default would trigger panic that other euro zone countries might suffer the same fate.

Mr. Cavalier noted that the worsening relations between Greece and its euro zone creditors in recent months hadn’t damaged business confidence or growth in the euro zone. He also added that the ECB had almost unlimited firepower to intervene in the bond markets to stem any panic if it desires.

Share prices fell too, with the German DAX index of 30 leading stocks down 1.7 percent. The euro edged down against the dollar to just over $1.10, and had fallen back below the $1.10 mark on Tuesday morning. Despite the relative calm, analysts warned that markets could be volatile in the days to come.

In Greece, the jubilation that followed Sunday’s defiant “No” was quickly forgotten, with the same queues forming in front of banks and the same hoarding of groceries. “Our problems are no different from yesterday,” said a newspaper kiosk owner at the central Syntagma square in Athens.

Most people seem well aware that Mr. Tsipras is unlikely to keep his promise to reach a deal with creditors “within 48 hours.”

On Egnatia Street, a main thoroughfare in the northern Greek city of Thessaloniki, traffic was as busy as ever and the cafes were full of people looking relaxed, as if nothing had happened. But each cash machine in the town had a queue of five or six people looking serious and worried.

“How is a family with children supposed to survive on €60 a day?” said Stella Serbou, who owns a textile shop Dragoumi Street in the center of town. She has hardly any customers these days. “People are using what little money they’ve got to buy basic food like rice or noodles. What does one need textiles for?”

Asked what she thought would happen to her business, she shook her head and said: “We just don’t know.”

 

Jan Hildebrand leads Handelsblatt’s financial policy coverage from Berlin and is deputy managing editor of the office here. Jan Mallien covers monetary policy for Handelsblatt Online out of Frankfurt. Jens Münchrath is based in Düsseldorf and heads Handelsblatt’s coverage of economics and monetary policy. He has been with the newspaper since 2000. To contact the authors: hildebrand@handelsblatt.commallien@handelsblatt.com and muenchrath@handelsblatt.com

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