The European Central Bank claims it can calm any regional market turmoil that follows Greece’s referendum on Sunday. Saving the country’s banking system will be harder.
With two asset-buying programs, international swap lines, backstops for eastern Europe and cash tenders in place, the ECB has a wide range of tools at hand should bond yields surge or money markets freeze after the July 5 vote. That’s a possible outcome if voters reject the terms of a European Union-led bailout.
Yet even if the Greek people back the EU offer, the nation’s lenders, which have been shut and under capital controls for the past week, won’t be able to reopen soon unless the ECB approves more liquidity. To do that, monetary-policy officials would have to take a leap of faith that the government will be able to strike a new deal.
“The linkages to the rest of the euro area are relatively small, though some of the more vulnerable countries may lie in Eastern Europe and to help there is definitely in the ECB’s remit,” said James Nixon, chief European economist at Oxford Economics in London. “None of that helps Greece though. We’re in deep, deep water there.”
The ECB’s Governing Council is due to discuss liquidity support for Greek banks on Monday. Vice President Vitor Constancio said on Friday that “the only thing that matters” is the chance of a deal between Greece and its creditors.
In the meantime, officials have prepared for the worst. The ECB now has more instruments at its disposal to contain ripples that threaten the stability of other banks, as well as legal backing from the European Court of Justice to use them as it sees fit, and has said it’s ready to do so.
With no room left for interest-rate cuts, the central bank’s most obvious option is more bond purchases. That could be done via its current quantitative easing or the untested Outright Monetary Transactions programs.
Executive Board member Benoit Coeure said this week that the ECB could develop “new instruments” to rein in market volatility, without saying what they might be.
The central bank also maintains a “full allotment” policy in its liquidity operations, so any bank with adequate collateral can borrow as much as it needs. That’s of little use to Greek banks though, as Greek debt isn’t rated highly enough to qualify.
Policy makers are willing to reach beyond both the euro and the euro area. Swap lines between six of the world’s major central banks that were set up during the early years of the sovereign debt crisis were made permanent in 2013, meaning lenders can access dollars, pounds, yen, Swiss francs and Canadian dollars if needed.
The ECB will provide Bulgaria with access to refinancing operations, offering euros to the banking system against eligible collateral, and is ready to assist other nations in eastern Europe, according to people familiar with the situation. That would help limit contagion in countries with a relatively high exposure to Greece. The ECB and the Bulgarian central bank declined to comment.
“The ECB is by far the most flexible and powerful source of policy support in the event of major financial contagion,” analysts including Guillaume Menuet and Antonio Montilla at Citigroup Inc. said in a note. “We have little doubt that the ECB would intervene.”
Mark Carney, governor of the Bank of England, said this week that finance ministries and central banks are in touch with each other over contingency plans.
“Those contingencies could be put in place if necessary,” Carney said in an interview with Sky News broadcast on Wednesday. “Quite frankly, they haven’t been necessary because we haven’t seen this spillover of the risks in Greece into broader financial markets or into broader Europe.”
Calm markets on Monday morning would still leave the ECB with a delicate decision though -- what to do with the Emergency Liquidity Assistance that has kept Greek lenders afloat through five months of crisis.
The Governing Council capped the aid, provided by the Greek central bank but needing ECB approval, after Greek Prime Minister Alexis Tsipras walked away from negotiations last week. The immediate consequence was that banks shut and the government imposed capital controls, restricting transactions and withdrawals from ATMs. With lenders now running low on cash, the ECB will have to decide if they should get more.
There is no easy answer. A “no” vote in the referendum, rejecting the EU proposal, would leave Greece without a bailout program and no obvious prospect of one. A “yes” vote would only open the door to new talks, perhaps with a new government, which may require time the banks don’t have.
To extend ELA, the ECB requires banks to be solvent and have adequate collateral. As long as the government can’t fund itself, those conditions are in doubt.
Greece might need emergency loans, European Parliament President Martin Schulz said in an interview with German newspaper Welt am Sonntag. One way would be to use 1.9 billion euros ($2.1 billion) of profits earned by national central banks from the ECB’s Securities Market Programme, the newspaper said, though the cost of recapitalizing Greek lenders would be at least 10 billion euros, according to an estimate it cited from an undentified official.
When Greek Finance Minister Yanis Varoufakis claimed in an interview with Bloomberg on Thursday that the banks will be open by July 7, he may have been unjustifiably optimistic.
“If it’s ‘no’ you’re back to the negotiating table, if it’s ‘yes’ you’re back to the negotiating table,” said Marchel Alexandrovich, senior European economist at Jefferies International Ltd. in London. “I don’t think things will be decided very quickly. The ECB isn’t really in a position to speed that process along.”