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Money out of thin air, or maybe not: Greece, the ECB and ELA

Posted on: 8 April 2015
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Filed under: Law Research, Uncategorized

All opinions are those of the blog post author and do not represent Westminster Law School or the University of Westminster.

I have discussed before how the ECB has gone about systematically shutting down funding avenues for the Greek government by first dis-allowing state bonds from being submitted as collateral for bank borrowing, and then keeping ELA under a short leash (see here). This has been widely condemned as being politically motivated, aiming to put pressure on Tsipras’ government to cave to the demands of the Eurogroup, as the Troika Bailout remains the only adequate source of government funding. I have argued (see here) how this squeeze can well lead to default and/or Grexit.

These actions of the ECB have created internal tensions between the monetary policy arm and the banking supervision team. Benoît Cœuré, Member of the Executive Board of the ECB, said in an interview with Arthur Beesley for the Irish Times on 12 January (published on 16 January 2015, see here) that the ECB has a rule that any government collateral can be accepted under monetary policy operations either only if its credit is rated well enough or, if it’s not well rated enough, if the country is under an EU/IMF programme. And this is not new. This has been ECB policy since 2010. Second the ECB has made it clear that the so-called Securities Market Programme portfolio of Greek bonds bought by the ECB cannot be restructured because that would be equivalent to granting an overdraft to the country and that would be contrary to article 123 of the treaty.

It is fine to say that the Greek state cannot finance itself through the back door, by getting its commercial banks to borrow from the ECB to lend to the government (see here). However, it is quite another to try and prevent this from happening through ELA lending that passes via the NCB with the argument that commercial banks are endangering themselves by pilling on too much state debt (with the ECB implying that the sovereign is of questionable stability). What the ECB has done, after stopping accepting Greek bonds as collateral, is to drip feed ELA through the BoG while at the same time trying to prevent the Greek banks from buying any more state bonds (see here). The ELA is meant to go to commercial banks to help with liquidity at a time where deposits are bleeding away in a slow motion bank run (which gets worse as time goes by and no agreement with the ‘ex’ Troika is reached).

Thus far the story is known. The latest news (March 2015) touch a different aspect of bank recapitalisation, that of ECB funding for state-guaranteed bonds. This is another kettle of fish than the sovereign bonds (discussed above) that the ECB no longer accepts as collateral for Greece. While the ECB had prevented commercial banks from depositing sovereign bonds as collateral to borrow direct from the ECB, it continued to directly accept commercial bank bonds guaranteed by the Greek state. This is no more. The Governing Council of the European Central Bank (ECB) has adopted Decision ECB/2013/6, which prevents, as of 1 March 2015, the use as collateral in Eurosystem monetary policy operations of uncovered government-guaranteed bank bonds that have been issued by the counterparty itself or an entity closely linked to that counterparty. As of that date, the Eurosystem will also no longer accept covered bonds issued by the counterparty where the asset pool contains uncovered government-guaranteed bank bonds also issued by that counterparty or an entity closely linked to that counterparty. This Decision, which aims to ensure the equal treatment of counterparties in Eurosystem monetary policy operations (supposedly!) and simplify the relevant legal provisions, follows the measures implemented on 3 July 2012, which limited counterparties’ use of uncovered government-guaranteed bank bonds that they themselves have issued. This decision has been implemented by means of the recasting of Guideline ECB/2012/18. In the interests of clarity and simplicity, the recast Guideline ECB/2013/4 now also includes the provisions of other existing legal acts on temporary measures (namely Decisions ECB/2011/4, ECB/2011/10, ECB/2012/32 and ECB/2012/34).

This little known practice (now unavailable for Greek banks) worked as follows, in the words of Varoufakis himself (see here): Bank X would lend money to…itself. It would do this by issuing a bond which it did not intend to sell. So, why issue such a phantom bond? Why write an IOU and give it to one’s self? The answer is: In order to hand this phantom bond over to the European Central Bank as collateral in exchange for a cash loan. Normally, of course, the ECB would never accept such a phantom bond as collateral. Accepting it would have been to accept a loan it gave to Bank X as collateral for the said loan. It would have been an assault on the meaning of collateral and a gross violation of the ECB’s rulebook. So, bank X, knowing this, took its phantom bond first to the Greek government and had it guarantee it. With the government’s guarantee stamped on it, the ECB then accepted Bank X’s phantom bond and handed over the cash. Why? Because the Greek taxpayer had, in the meantime, unknowingly provided the collateral for Bank X’s loan.

Some European governments (Greece included) had launched schemes guaranteeing bonds issued by credit institutions shortly after the outbreak of the financial crisis in order to support their banking systems. Nevertheless, this market development suggests that the introduction of the eligibility of own-use government-guaranteed bonds accompanying the suspension of the minimum credit rating has also allowed a substantial fraction of these increasingly issued bonds to find their way into reverse transactions for refinancing credits with the ECB. Government guarantees are of importance because of two reasons. Firstly, government guarantees for risky assets pose a risk for taxpayers in case of bank default. Secondly, government guarantees can influence the valuation of the collateral as well as its credit rating, and thereby its refinancing conditions. In February 2009, the ECB extended the acceptance of own-use assets to all those guaranteed by governments. In principle, this made it possible to securitize assets into bonds, which are retained, thus never assessed by the market or a rating agency, and can still be used as collateral for refinancing credits due to the government guarantee. Moreover, the conditions in terms of valuation haircuts would be appealing if the rating of the guaranteeing government is higher than that of the issuer. (see here for details)

Why is all this important? The reason is that this latest change restricts Greek commercial banks to the ELA for liquidity support. This puts the burden on the BoG and allows the ECB to restrict its exposure to the Greek banking sector (and possible losses in case of sovereign and banking collapse). As the NYT recently argued (see here) to tap the ELA credit line, currently at €71 billion (more than half the deposits outstanding in Greece), Greek banks need to provide collateral to the Greek central bank. As was the case in Cyprus during its banking crisis, when a financial system implodes, finding acceptable collateral to swap for desperately needed loans can be difficult. The solution had been (as described above) for the banks to manufacture and issue billions of euros of short-term bonds, which — because they carry the guarantee of the Greek government — can be used as collateral to secure much-needed cash from the BoG via ELA. As long as the bank’s problem is access to short-term funds and not solvency, such machinations can work. In the last year or so, Greek banks have issued more than €50 billion worth of these securities at artificially high interest rates (the higher the rate, the more valuable the collateral becomes in securing loans). There appeared to be no restriction on the banks using these bonds to tap credit from their own central banks, and they have done so. The most recent case occurred recently, when Piraeus, Greece’s largest bank, issued a €4.5 billion note at 6 percent, which matures in July 2015. Bringing this rather dodgy practice under the ELA means that there is now a limit to this funding avenue and less room for manoeuvre for the Greek government.

Dr. Ioannis Glinavos: i.glinavos@westminster.ac.uk

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