The ECB's in a Tight Spot Over Greece

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Hollande, Merkel Set May Deadline for Greek Reforms

European Central Bank policy makers will discuss Greek bank aid on Wednesday in a chore that is getting more uncomfortable every week.

The Governing Council is due to meet in Frankfurt to debate the Greek central bank’s request for an increase of 1.1 billion euros ($1.2 billion) in the emergency funding it can offer lenders, people familiar with the matter said. As Greece veers toward default, ECB officials are aware that their response could worsen the political crisis just as bailout talks show signs of progress.

ECB President Mario Draghi has repeatedly said politicians rather than unelected central bankers must decide on Greece’s future, and council decisions will be based on rules such as the solvency of its banks and a prohibition on state financing. European leaders will have their next chance at a summit on Thursday in Riga, Latvia.

“It’s very simple: the ECB doesn’t want to be the one that pulls the plug on Greece when political negotiations are still ongoing,” said Marco Valli, an economist at UniCredit SpA in Milan. “As long as there is the chance that Greece will remain solvent, that it might receive further European Union aid, then ELA can be given. Should this possibility disappear, then it will have to stop.”

The ECB may be reluctant to approve the full ELA request as the Bank of Greece still has a cash buffer available and deposit outflows stabilized last week, the people said, asking not to be named as the matter isn’t public. Spokesmen for the ECB and the Bank of Greece declined to comment.

Debt Rollovers

The Athens Stock Exchange was down 0.3 percent at 3:56 p.m. local time. The yield on the Greek government’s 10-year bond yield rose 2 basis points to 11.1 percent.

ELA for Greece currently stands at 80 billion euros and is intended to replace outflows at the country’s lenders. Those losses have mounted in recent months as the government’s reluctance to commit to economic reforms blocks international aid payments. The Governing Council reviews ELA weekly and can curb it with a two-thirds majority in a vote.

Signs of progress in the bailout talks are now emerging. Greek Prime Minister Alexis Tsipras will submit a new proposal on sales tax in the coming days after an initial offer didn’t pass creditors’ muster, people familiar with the matter said Tuesday. He ’ll present a debt restructuring plan at the Riga summit, Ta Nea newspaper reported Wednesday.

Real Progress

European Union Economic and Monetary Commissioner Pierre Moscovici told the French Senate on Wednesday that real progress has been made in the past three weeks. German Chancellor Angela Merkel said on Tuesday that Greece has until the end of the month to reach a deal.

Without bailout cash, Greece risks defaulting on its debt. The country won’t be able to make a payment to the International Monetary Fund due June 5 without a deal with its international lenders, the government’s parliamentary speaker was cited by Reuters as saying.

The ECB’s dilemma is that the solvency of the government and banks is linked by the roughly 9 billion euros of treasury bills that Greek lenders hold and regularly roll over.

The Bank of Greece may accept a further 6 billion euros in additional assets as eligible collateral for ELA operations, giving banks more leeway, Market News International reported on Wednesday. An ECB spokesman declined to comment on the report.

Cash Crunch

Banks currently have enough collateral to stretch the ELA lifeline to about 95 billion euros under the terms currently allowed by the ECB. At the current rate of increase, that could mean they reach their limit by the end of June.

The crunch might come earlier though, should the Governing Council decide to increase the discounts on the collateral posted by banks in return for ELA. If those so-called haircuts are increased to levels not seen since late last year, the maximum emergency liquidity available would drop to about 88 billion euros.

That could happen should policy makers decide that easier haircuts introduced at the end of 2014, when Greece’s return to markets seemed within reach, are no longer appropriate. As long ago as April 25, Bundesbank President Jens Weidmann said he had doubts about the provision of ELA.

Greek newspaper Kathimerini reported on Wednesday that the ECB may “imminently” raise the discount and offset tighter rules by expanding the pool of assets it accepts as collateral.

That move would address concerns that restricting the funding situation of Greek banks pre-empts the political talks. European Union leaders will meet in Riga starting on May 21, though European Commission President Jean-Claude Juncker has ruled out a pact being reached at the summit.

‘Very Close’

The risk of default may be focusing minds on both sides of the table, a shift that Draghi and his colleagues are likely to take into account.

“As long as negotiations are ongoing and taking place in good faith, the ECB doesn’t want to be the one pulling the straws,” said James Nixon, an economist at Oxford Economics Ltd. in London. “The ECB will continue to refer to political progress, increase ELA and keep collateral requirements unchanged. As soon as there are signs that political progress is becoming unhinged, the ECB’s stance would change immediately.”

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