The closure of the Greek banking system has severely disrupted the Greek economy and the lives of millions of Greek citizens, and has sharply escalated the financial crisis in the country. What caused the Greek banks to close?
The general narrative about Greece tends to collapse a very complex situation and history in to a simple story: the Greeks spent too much, borrowed too much, got into debt and ran out of money. In the context of this simplified version of events it would be easy to think that the closure of the Greek banks is just part of the general process of Greece running out of money and is a natural consequence of the financial crisis and of Greek profligacy. But that would be wrong.
It is very important to understand that the Greek banking crisis has been deliberately created, primarily by the European Central Bank, for purely political reasons to put political pressure on the Greek government and to scare the Greek people prior to todays referendum.
Before looking at specific causes of the Greek banking crisis it is important to clarify how and why banks can go into crisis and be forced to shut. In particular it is really important to understand the difference between a crisis of insolvency and a crisis of liquidity.
When a bank becomes insolvent it is because its liabilities (money it owes) have become bigger than its assets (money it is owed). An insolvent bank is a bust bank. Insolvent banks have to be either closed or rescued by an injection of capital because no matter how much money they are lent they will always remain insolvent. Borrowing money would increase a banks assets but as its liabilities would go up by the same amount its position of being insolvent would remain unchanged.
A crisis of liquidity is very different to a crisis of insolvency. Any bank, even though it has a healthy balance sheet and has plenty of assets to balance its liabilities can suffer from a crisis of liquidity because all banking eventually depends on borrowing short (from depositors who can withdraw their money at a moments notice) and lending long (investing in long term assets). So if enough depositors all ask for their money back at the same time a bank can run out of cash even though it is solvent. Such crises of liquidity are very common in banking and vast amounts of interbank lending and borrowing, trillions of euros, are done every day to prevent banks from running short of cash.
If it is impossible to borrow cash from other banks, or as in the case of Greece if lots of banks in an entire banking system are simultaneously running out of cash, then central banks must step in and lend the illiquid banks some cash. This is a core function of central banks, being a lender of last resort, and is possible because central banks can create any quantity of money they want. This is often called printing money but its actually done nowadays by just typing the figure into the central bank computer systems. All big banks have accounts at their relevant central bank and when a bank, or lots of banks at once, start to run out of cash, the central bank creates new money in its computer system and transfers the funds to the reserve accounts of the bank that are running low on funds and the bank can then meet the requests of its depositors for their cash. The central bank asks for the banks borrowing the cash to offer up some sort of collateral and this is an important part of the central bank determining whether the problem at the bank is one of illiquidity (in which case it will have enough assets and the central will be right to lend it some cash) or a problem of insolvency (in which case the bank will not have enough assets for collateral and lending it further cash would be pointless – it would be bust).
So to reiterate a crucial point. It is widely accepted that any central bank should be to willing to lend in unlimited size at reasonable prices to banks that it thinks are solvent. In other words, if it looks like a private bank’s assets would be worth more than its debts outside of a current acute liquidity crisis, the central bank should be willing to lend as much as is needed during a crisis to prevent that bank from failing. This is literally central banker orthodoxy. Except apparently in the eurozone.
The Greek bank run
Since last year there has been an escalating bank run in Greece. Lots of Greeks and Greek businesses, for perfectly sensible reasons, have been withdrawing their bank deposits or shifting their funds from Greek banks to banks abroad. This is because they all fear that if Greece were forced out of the Euro then the new Greek currency would drop in value. So if they can hold onto Euro bank notes or hold their cash abroad and a new Greek currency comes into existence then, when the dust settles, they can all convert their Euro denominated cash holdings into the new currency and it would not lose any value.
Greek bank deposits have been falling steadily since October and now stand at their lowest level since 2004. Withdrawals in recent weeks have averaged €200-250m a day, but as it became apparent that the talks between the Greek government and its eurozone and international lenders were breaking down the withdrawals surged to €400m. Billions of Euros have left the Greek banks and this has left them with not enough cash.
So as a consequence of this massive bank run across the Greek banking system the banks have turned to their lender of last resort which is the Bank of Greece (BoG). But the Bank of Greece is completely under the control of the European Central Bank (ECB), as are all national central banks in the eurozone, and the (BoG) can only issue new cash to the Greek Banks if the ECB approves it.
The ECB has a procedure in place to carry out this basic function of central banking, being a lender of last resort, called emergency liquidity assistance (ELA). It was never clearly stated when it was created that the ECB was actually lender of last resort but the eurozone crisis that erupted in 2010 saw numerous liquidity crises and the ELA mechanism was created, rather reluctantly by the stern Ordorliberals of the ECB, to deal with liquidity problems. When a national central bank in the eurozone receives request for ELA from a bank, or in Greece all the banks, it passes the request to the ECB HQ in Frankfurt and the ELA is only approved if the recipient bank is deemed to be solvent and can produce some form of suitable collateral. Most often the collateral used in these situations are government bonds and in the case of Greek banks this is almost entirely Greek government bonds. These Greek bonds are not marketable in the actual markets (because nobody wants to buy old low interest rate Greek bonds at the moment) and that is why they are only accepted by the ECB as meeting ELA requirements with a ‘haircut’. The term ‘haircut’ just means that the nominal value of some assets such as a bond is reduced by a set amount. There are no official records but there is some information that the current haircut is around 40% at the moment. That means that for every Greek bond with say the nominal value of one billion euro that a Greek bank is holding it only actually gets 600 million euros in ELA cash. Obviously the size of the haircut imposed by the ECB is critical and if, for example, the ECB were to decide to cut the name value of these bonds by 75% (a number which has been mentioned in bankers circles) then the ability of the Greek banks to borrow money at an acceptable rate will be so hindered to such an extent that the banks might even become insolvent. The ECB could make the Greek banks insolvent if it wanted to (which would be a bizarre thing for a central bank to do), but under current conditions they are not insolvent.
As well as the issue of the size of the ‘haircut’ imposed on the Greek bank’s collateral there is also the issue of the volume of funds being offered by the ECB under the ELA mechanism. As mentioned earlier there should be no limit by a central bank to the funds it will lend to a bank that is suffering a liquidity crisis as long as the bank is deemed to be solvent.
As the tensions and uncertainties about the negotiations between the Greek government and the Troika have increased so the scale of the Greek bank run has grown and this has meant that the volume of ELA being given by the ECB has increased. However last week when the talks broke down and the referendum was called the ECB suddenly announced a cap on the amount of ELA being offered to the Greek banks. This, given the scale of continuing withdrawals, meant that the Greek banks had to shut their doors and cash withdrawals from ATMs had to be rationed. This had a devastating effect on the Greek economy and people.
Yanks Varoufakis said that in the final stages of the negotiations the Greek delegation were threatened that if they did not sign the deal by the deadline the ECB would shut their banks. And that is what it did.
The ECB decision to shut the Greek banks was purely political
Given that it is a basic duty of a central bank to provide adequate funding to any solvent bank suffering a liquidity problem did the Greek banks suddenly become insolvent a week ago when the ECB stopped giving liquidity support?
As part of its extensive health check of all banking in the eurozone the ECB carries out what are called ‘stress tests’ to see how well a bank could cope with future liquidity and credit shocks and how solvent they are. The most recent Comprehensive Assessment of the outcome of the stress tests published by the European Central Bank’s in October 2014 said that the three big Greek banks were adequately capitalised to survive a stressed scenario thanks to their fundraising efforts earlier in the year, while the fourth was only off by five basis points (one twentieth of a percent). The Greeks banks did better than some other banks across the eurozone.
If one looks at the ELA procedures, as published by the ECB, ELA is extended to “solvent financial institution, or group of solvent financial institutions, that is facing temporary liquidity problems, without such operation being part of the single monetary policy. Responsibility for the provision of ELA lies with the National Central Banks concerned” which can happily go on extending ELA unless “the Governing Council of the ECB [with a majority of two- thirds of the votes cast] considers that these operations interfere with the objectives and tasks of the Eurosystem”.
Mario Draghi, President of the ECB said as recently as 15 April that “[w]e approved ELA and we’ll continue to do so, extend the liquidity to the Greek banks while they are solvent and they have adequate collateral”. He had already said on 5 March that “the ECB is a rules-based institution […] and […] the decision about determining an ELA, are all the outcome of rules, not our political decisions. ELA is a decision of the National Central Bank of Greece, to which the Governing Council may decide to object with a very special and demanding majority requirement, if certain conditions are not in place. One condition is that ELA can be given to solvent banks with adequate collateral. The Greek banks at the present time are solvent. Their capital levels are well above the minimum requirements, and that’s positive news. [T]oday, the Greek banking system is solvent”.
At a press conference on 3 June, Draghi was asked “Mr. President, maybe you could elaborate again on your decision not to tighten the haircut rules for collateral used by Greek banks. The situation, the financial situation in Greece has deteriorated considerably since December when you took a lighter stance on this issue. So the whole thing looks like you’re — you said you are a rules-based institution and it looks like you’re making political considerations; not willing to interfere in the ongoing political process. How would you comment on that?”
What Draghi said in response was: “I would comment that it’s not true. Simply said, we are not either interfering or in any way taking a stance with respect to the current negotiations. We are a rules-based institution. But you have to understand that there are two different sets of rules: one is for collateral posted against monetary policy instruments, and the other one is the collateral posted against ELA”.
Draghi also said “We do assess how the developments in the markets affect the quality of our collateral, namely the quality of the Greek government bonds that have been posted as collateral. So were the conditions to change, we would certainly go through a series of things. Yes, we would have to revisit our previous decisions”.
In reality there are no rules for ELA collateral policy, as a report requested by the European Parliament’s Committee on Economic and Monetary Affairs flatly states, and the ECB has played fast and loose with this non-existent rulebook in the past In relation to both Ireland and Spain (see my previous article).
Greek banks had total assets of €391billion as at May 2015. One would think these assets should be enough to support €95 billion of ELA they have received so far with quite some room for more if needed. But suddenly last week a request for an extra €6 billion of ELA was refused. If these €391billion in assets are not worth even €96 billion, then Greek banks, which have liabilities of around €322 billion, would be insolvent, and they would have been insolvent for quite some time. Blocking the ELA request for another €6 billion makes no sense – unless it was a political act intended to pressure the Greek government and affect the Greek referendum. The ECB, a body outside of any democratic control or even oversight has no mandate or legal basis for making such a political intervention.
Are Greek banks insolvent then? The institution which determines this is the Single Supervisory Mechanism (SSM) and the SSM is part of the ECB. Let’s then look at the response of the head of the SSM, Danièle Nouy, when asked as recently as 7th June whether “she may perhaps have slight doubts about [her] earlier statement that Greek banks were absolutely solvent and liquid”:
“No, I don’t: these banks continue to be solvent and liquid. The Greek supervisors have done good work over the past years in order to recapitalise and restructure the financial sector. That was also visible in the outcome of our stress test. The Greek institutions have experienced difficult phases in the past. But they have never before been so well prepared for them”. If her views had changed in less than three weeks, wouldn’t she have said something about this, if only to the banks themselves, which would then have a legal duty to disclose it? Wouldn’t she have asked Greek banks for a capital increase perhaps?
It is clear that the ECB has done the exact opposite of what a central bank should do when dealing with a banking liquidity crisis. It has been party to inflammatory remarks, especially by the Bank of Greece (an institution under its control) whose predictable effects have been to worsen the Greek bank run. The ECB then took the extraordinary decision to shut down liquidity support for the Greek banking system thus causing the banks to shut, and thus dramatically worsened the financial situation in the country.
Didn’t Draghi say four times in his press-conference of 5 March that the ECB is a “rules-based institution”? Didn’t he repeat that twice in his 3rd June press conference? Shouldn’t the ECB make public the reasons, calculations and rules that made it suddenly decide to make the momentous decision to cap ELA payments and thus close the Greek banking system a week ago?
The millions of Greeks queueing in front of ATMs would love an answer, and they deserve one.
