ECB's balancing act

Following the victory of the “No” vote in Greece’s referendum, the ECB decided to continue providing Greek banks with access to Emergency Liquidity Assistance (ELA).
The haircut on collateral was nonetheless adjusted to take into account the deteriorating of financial situation of the Hellenic state and banks. The size of the tightening move was not revealed but the fact that the liquidity ceiling was maintained at the same level suggests that it won’t significantly deteriorate the liquidity position of the Greek banking sector in the very short term.
The ECB is once again walking a tight rope, wanting to limit its influence in the political arena while at the same time trying to preserve its credibility.
The ball is now in the politicians’ court. The next deadline is approaching quickly with the repayment of EUR 3.5bn in Greek bonds due to the ECB on 20 July. In case of a default, things would become much more complicated for the banking sector, but it would not necessarily imply the end of ELA financing.

The ECB maintained its lifeline to Greek banks by continuing to provide Emergency Liquidity Assistance (ELA) on Monday evening, 24 hours after the referendum’s “No” vote on the terms of a bailout agreement. Nonetheless, the ECB decided to “adjust” the haircut on collateral used in ELA operations: Greek banks will have to provide more assets to guarantee central bank funding.

Once again, the ECB’s decision illustrates the tightrope act it has had to perform since February, balancing the willingness to limit its political influence against the need to preserve its credibility. As the ECB president has pointed out repeatedly, the European Central Bank must follow rules and cannot act decisively towards Greece without a political decision that clarifies the situation.

It was therefore unthinkable that the ECB would decide to cut off Greek banks access to central bank liquidity – which would be synonymous with the country’s de facto exit from the monetary union – just as negotiations are about to start up again between the country and its creditors, and as long as there is still hope that they can reach an agreement on fresh financial help. Yet the ECB also had to acknowledge the deterioration in the solvency of the Greek banking sector, which is highly dependent on the government’s financial situation. This is precisely why the ECB decided to adjust the haircut on collateral.

The ECB press release did not stipulate the size of the tightening move, but the fact that the liquidity ceiling was maintained suggests that it is unlikely to significantly deteriorate the liquidity position of the Greek banking sector – which is already in bad shape – in the very short term. Capital controls were not tightened as some had expected. Though slowed by ceilings on deposit withdrawals, the erosion of the deposit base is drying up Greek banks a little more each day, increasing pressure on the Tsipras government. It is very difficult to know precisely the financial health of the Greek banking sector, but one thing is certain: without an agreement between the Greek government and its creditors in the short term, Greek banks will be unable to meet their liabilities.

By moving before negotiations resume between the Greek government and its European counterparts, the ECB is also taking a stance in which it can avoid reacting to the turbulence that is likely to accompany talks over a new bailout plan following the referendum’s resounding “No” vote. The ball is now in the court of politicians. The next deadline is approaching quickly with the repayment of EUR 3.5bn in Greek bonds due on 20 July. A Greek default would make things much more complicated for the banking sector, threatening its access to emergency liquidity. However, the ECB could be reluctant to make a decisive and irreversible move without a political decision that supports its action. The balancing act could continue, despite an increasingly precarious situation.

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