9 July 2015 — Decoupling the Banks from the Greek Government
The reason why finding an exit from the Greek quagmire is so difficult is the strong link between the Greek banking system and the sovereign.
I have explained elsewhere in this blog (see here) how the Greek government has been syphoning liquidity off the Eurosystem in indirect ways through its banks. Once Greece stopped receiving bailout funds from the Troika last summer, it relied on turning over short term paper (T-Bills) through the domestic banking system. What prevented this from becoming the main avenue of financing is the ceiling imposed by the ECB on the holdings of GGBs. The way this worked was by banks buying GGBs, depositing them (initially with the ECB, before the waiver was lifted) with the BoG as collateral and drawing liquidity through ELA. ECB data show that Greek banks hold €13.6bn of bills and €30bn of Greek sovereign-guaranteed financial instruments.
The significant holdings of GGBs in the private banking system however create a deathly embrace between the Greek government and the Banks. If the government defaults comprehensively on GGBs it will blow a massive hole in banking balance sheets, pushing them into insolvency. You could argue, that Greece does not even need to default. As GGBs trade now on quasi-default ratings, a fair-value-accounting standard would again show liabilities rising on the balance sheet. We are now facing a banking system without any liquidity -due to the bank run- a hole in its assets (not counting the avalanche of non-performing loans) and without any further assets to place as collateral in order to benefit from ELA support. The ECB’s latest haircut on GGBs, and moves to restrict other forms of financing through guaranteed ‘phantom’ bonds (see here) making things worse.
What I am trying to say here is that the banking system is as dead as the dodo. How can the ECB in these circumstances fulfil its role as a guarantor of systemic stability for the Euro and ensure the stability of the banking system? One idea is to try and decouple the banks from the sovereign by swapping their holdings of GGBs with other paper, not subject to the impairments that the GGBs are suffering as Greece is defaulting left and right; to recapitalize and restructure these banks, to enable them to function without relying on Greek government-issued or government-guaranteed collateral. The need for additional collateral would be for potentially up to €45 billion, even though restructuring of the banks (potentially bailing in some time deposits in Greek banks) and higher collateral valuations than for the existing collateral could bring the total amount of capital needed from external sources down significantly.
What would you swap Greek paper with? ESM paper is the answer. The ESM would thus become the main (perhaps the only) shareholder in the Greek banks. These banks would continue to have access to routine ECB funding, and to ELA if necessary, provided they are deemed solvent and can offer adequate collateral, unrelated to the government. [see here for references]
Of course, the consequence of keeping the banking system alive but excluding the sovereign would mean that Greece stays in the Euro, but the state defaults on external, and most internal, debt. The state would be unable to borrow from its own banking system, would be unable to pay wages and pensions. A parallel currency or IOUs would probably need to be introduced (see here).
Not a pleasant situation, but let us not forget that the alternative is Grexit, nationalisation of the banks, probably a significant haircut on deposits and re-denomination of whatever is left in drachmas whose value (in the absence of foreign exchange reserves- see here) will soon sink like a rock.
Another day in paradise in other words.