The European Central Bank board is meeting today to discuss the emergency funding provided to Greek banks in the aftermath of yesterday's referendum result.
Without an increase in the size of the Emergency Liquidity Assistance (ELA) facility -- currently limited at €88.6 billion ($97.5 billion) -- Greek banks are likely to remain closed for some time yet.
But what is ELA, and why is it so important for the banks in Greece?
First, a bit of background. The ECB, in the normal course of events, provides liquidity to banks through its refinancing operations. In these operations, the central bank provides liquidity to banks in the euro area, and those banks in turn provide the ECB with high-quality assets as security, or collateral, which the ECB can lay claim to in the event that there is a failure to repay.
There have been failures to pay before, most famously when Lehman Brothers defaulted on about €8.5 billion worth of liquidity loans from Germany's central bank. The Bundesbank held the collateral backing those loans and over the course of a number of years managed to recoup most, if not all, of that amount.
The ECB currently runs its liquidity operations on a "full allocation" basis, so banks should be fully supplied with all the liquidity they need, as long as they have sufficient high-quality collateral.
ELA comes into play when banks no longer have sufficient high-quality collateral, or are suffering a severe liquidity crisis, the likes of which we have seen in Ireland, Cyprus, and Greece over the past few years.
ELA is granted by the domestic central bank -- not the ECB -- against collateral that is often guaranteed by the sovereign state. The ECB, for its part, maintains a supervisory role over the operation and retains the right to limit any ELA operation.
As ELA is often collateralized by instruments guaranteed by the local government, the ECB's opinion regarding the value of that guarantee becomes critical in its decision to extend ELA.
In the case of Cyprus in 2013, the ECB was concerned enough about the value of the Cypriot guarantee-backed ELA provided by the Central Bank of Cyprus that it issued this unprecedented press release, which stated: "The Governing Council of the European Central Bank decided to maintain the current level of Emergency Liquidity Assistance (ELA) until Monday, 25 March 2013. Thereafter, Emergency Liquidity Assistance (ELA) could only be considered if an EU/IMF programme is in place that would ensure the solvency of the concerned banks."
If Cyprus wasn't in a program, the ECB judged its guarantees to Cypriot banks insufficient to allow ELA.
Cyprus signed up for a troika program within days of this ECB press release, and ELA continued.
Which brings us up to today.
Greece is in a similar situation to Cyprus in March 2013 in that it is not in a program. This means an extension to ELA today is almost certainly off the cards. But, unless the ECB holds out no possibility at all of Greece entering a new program in the near future, it is unlikely to switch off ELA, as it threatened to do with the Cypriot banks.
Removing ELA altogether would instantly make the Greek banking system insolvent as it would not be able to meet the repayment to the Bank of Greece. Further, the state guarantees in place could not cover the losses that the Bank of Greece would suffer under these circumstances and so that central bank would -- depending on how it chose to account for those losses -- need to recapitalize. Unfortunately, the shareholder liable to cover those losses is also the Greek state.
Finally, ELA, although it is a national central bank operation, does appear on the ECB balance sheet. Which means if there is no hope of recovery from the Bank of Greece, then the ECB would have to figure out a way of accounting for the loss, or recovering the collateral that secured the loans.
Clearly, it is in nobody's interest while there is any hope, however slim, of a new Greek bailout to end ELA. The accountancy headache alone may be enough to stay the ECB's hand -- for now.