An outflow of deposits from Greek banks will put pressure on the government to limit how much money people can withdraw or transfer outside the country as European Union nations lose patience with providing a lifeline.
Imposing capital controls, as Cyprus did two years ago when its banks faced a crisis, would buy time for Prime Minister Alexis Tsipras’s government to negotiate debt relief, according to economists including Daniel Gros, director of the Centre for European Policy Studies in Brussels.
“Capital controls may be the only option to stop the bleeding in the banking system,” Gros said in an interview.
The European Central Bank told Greece Wednesday that its banks can no longer use their nation’s government bonds as collateral to access direct ECB funding. While the Frankfurt-based central bank said Greek banks are able to borrow indirectly through their own central bank for now, talks between Greece and euro-area countries could drag on for months.
Finance Minister Yanis Varoufakis said the government will present a detailed proposal for a debt swap by the end of February, when the current bailout agreement expires, and seek to reach a deal by June. Germany expects negotiations to continue through April or May, a person with knowledge of the matter said this week.
Greek banks probably lost about 21 billion euros ($24 billion) of deposits in the past two months, or 11 percent of the total as of the end of November, according to the ECB and estimates last week by JPMorgan Chase & Co.
Depositors are withdrawing money now because they’re worried a refusal by the government to extend the bailout when it expires at the end of the month could lead to an exit from the euro area. That would mean waking up one morning and finding their savings converted to drachma, which would face a steep devaluation. Putting the money in another European bank or keeping it as cash at home would protect them from losses.
Similar worries led to an earlier episode in 2010. Greek banks lost about 85 billion euros of deposits in the 21 months after the country received its first bailout from the European Union and before a restructuring of government debt. The funding was replaced by ECB financing, which peaked at 158 billion euros in 2012. Deposits stabilized after the restructuring, and Greek banks reduced their reliance on central bank funds by shrinking balance sheets and raising capital.
That trend reversed in December in the run-up to the Jan. 25 election. Customers withdrew 6 billion euros in December, central bank data show. They pulled out an additional 11 billion euros in the first three weeks of January, and the total for the month may have reached 15 billion euros, JPMorgan analysts estimated. That would be more than was withdrawn in May 2011, the month with the biggest drop in the earlier crisis.
Under terms of the bailout, the ECB stepped in to fill the gap. With Wednesday’s move, the central bank has signaled that Greek lenders will face a harder time accessing ECB liquidity if the bailout program is suspended.
Euro-area banks can only use investment-rated government bonds as collateral to borrow from the ECB. Greek government bonds were given a waiver because of the bailout. That waiver can no longer be granted because of the uncertainty facing the program’s future, the ECB said. The new Greek government has said it doesn’t plan to extend the bailout when it expires at the end of the month.
The ECB said Greek banks can still use another type of funding from their national central bank that has less rigid collateral rules. That emergency borrowing has to be approved every two weeks by the ECB. If the central bank refuses to extend this type of lending, Greek banks would run out of cash quickly, as they already rely on ECB funding for about 70 billion euros they can’t replace because they have been shut out of capital markets since November.
That would force Greek banks to cut lending to companies, consumers and the government. They’d be unable to roll over treasury bills and might recall loans. Greece would have to abandon the euro and print its own currency to fund its banks.
“Given how extreme this option is, the ECB might instead impose a Cyprus-like solution of withdrawal and capital-transfers controls,” said Nicholas Economides, an economics professor at New York University.
While only national governments have the power to impose capital controls, and doing so is in violation of the European Union treaty, the ECB gave tacit approval when Cyprus did just that in 2013. The central bank had threatened to cut off all liquidity to Cypriot lenders if the government didn’t reach a deal with its European partners.
“The experience of Cyprus suggests that you cannot completely rule out capital controls any more as a policy option,” said Jens Bastian, a former member of the European Commission’s Greek task force who’s now an independent analyst based in Athens. “The situation isn’t so dire yet, but it could get there.”
Capital controls would be painful and unpopular with the Greek public, putting even more pressure on Tsipras to reach an agreement sooner rather than later, according to Gros of the Centre for European Policy Studies.
“The popularity of the government will plummet, and the economy would be hurt too,” Gros said.
While Greek and EU officials say they want to reach an agreement, the longer the talks last, the greater the risk of an exit from the euro area, according to Raoul Ruparel, head of economic research at London-based Open Europe.
“If the deposit flight is continuing while things drag on, the euro zone wouldn’t want to increase its exposure to Greece through rising ECB financing,” said Ruparel. “Then they’d push for capital controls as a way of limiting further exposure in case things don’t work out and Greece ends up exiting. It’s an option nobody wants, but it will become likelier the longer the type of brinkmanship we’ve seen recently continues.”
Even though they’ve been loosened, capital controls remain in place in Cyprus. While they have been successful at stemming deposit outflows and stabilizing the banking system, the country is stuck in a three-year-long recession.
In the case of Greece, controls probably would only work for a few months as Tsipras’s government negotiates a new debt deal with its European creditors, according to Benn Steil, director of international economics at the Council on Foreign Relations in New York. Without an agreement, restrictions on withdrawals wouldn’t be enough to keep Greece in the euro zone.
“The Grexit could happen slowly, not in a big bang as we always imagine,” Steil said. “It could come after capital controls and other ways of scrambling to continue.”