ECB, ELA and Grexit

by George Hatjoullis

Last night the ECB notified the Greek government that it would lift the waiver on Greek debt in respect of its eligibility as collateral in normal monetary operations with the ECB. This means Greek banks (and any other banks) that hold Greek sovereign debt or sovereign guaranteed debt, cannot use it as collateral when obtaining liquidity from the ECB. This action was hailed universally as a political gesture designed to bring Greece into line. It was nothing of the sort. The waiver was always conditional on Greece being within a troika recovery programme. Varoufakis presumably notified Draghi formally that Greece intended to exit this programme unilaterally. This left the ECB no choice but to lift the waiver. To not do so would have been a political decision and one that would have been challenged in Germany as illegal as it might constitute a subsidy by the ECB to Greece and thus monetary financing. The twitter-sphere exploded with indignant but uniformed comments from so-called financial journalists determined to sensationalize an inevitable event.

The ECB cannot engage in monetary finance. This means it cannot allow a haircut of any Greek debt that it owns. It also means it cannot convert the debt it owns into perpetual debt, as Varoufakis is suggesting creditors of Greece might do. It may, depending upon the precise structure and terms, be able to consider swapping debt for growth-linked bonds provided it has a maturity date and provided this cannot be interpreted as wilfully taking a loss. However, this might be a difficult construct as it may confer little benefit to Greece in terms of debt relief. The ECB can also allow the national bank of Greece to engage in Emergency Liquidity Assistance (ELA) unhindered. Draghi spoke to Tsipras, the Greek PM, and informed him that, for the moment, ELA finance for Greek banks would continue unhindered.

The structure of the ELA is a little odd. Any loss incurred by the Greek central in providing such assistance is a liability of the Greek state, which precisely why the ECB does not need to be so strict. In principle Greek banks can fund themselves, and the Greek state, through this source of finance. Let unhindered, ELA is a sort of monetary finance of the Greek state by the Greek central bank. However, if it is deemed to be working this way it will not be left unhindered. The ELA exists to stop a liquidity crisis in an otherwise solvent banking system. The recent ECB run stress tests deemed the system by and large solvent. The ECB can restrict ELA if it feels it would disrupt the eurosystem but only by a 2/3 majority of votes cast by the governing council. Under what circumstances might it do this?

The simple conclusion is that the ECB will be very reluctant to restrict ELA. First, it allowed the central bank of Cyprus to extend ELA to a banking system known to be insolvent. It did so because to not do so would have de facto removed Cyprus from the eurozone. An abrupt removal of any eurozone member from the eurozone might be the most disruptive event for the eurosystem! Second, removing a member state from the eurozone is a political decision. The Treaty of Lisbon defines membership as irrevocable. It is hardly appropriate for the ECB to effect an outcome that Treaty defines as irrevocable. ELA is thus unlikely to be restricted. If it is then the condemnation by the twitter-sphere for de facto ejecting Greece from the eurozone would be justified. It should also be noted that the word ‘irrevocable’ in the Treaty creates many legal obstacles to Greece being unwillingly ejected from the eurozone.

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