Thursday, August 25, 2011

Run on the Greek banks continues [updated]

A Telegraph article reports that Greece was forced to tap an emergency fund for its banks because they were running low on collateral to pledge to the ECB.

Previously, as depositors withdrew funds, the banks would turn to the ECB for funding.  However, the run on the banks has now exceeded the good collateral the banks have to borrow against.
In a move described as the "last stand for Greek banks", the embattled country's central bank activated Emergency Liquidity Assistance (ELA) for the first time on Wednesday night. 
Raoul Ruparel of Open Europe told The Telegraph: "The activation of the so-called ELA looks to be the last stand for Greek banks and suggests they are running alarmingly short of quality collateral usually used to obtain funding." 
He added: "This kicks off another huge round of nearly worthless assets being shifted from the books of private banks onto books backed by taxpayers. Combined with the purchases of Spanish and Italian bonds, the already questionable balance sheet of the euro system is looking increasingly risky." 
Clearly, there is the potential for shifting the losses on these assets to the taxpayers.

However, that is not necessarily the case.  Regular readers might recall the posts on central banks can offer a free lunch (see here, here, and here).  The idea behind the free lunch is that central banks do not have a cost of carry for any asset they purchase.  As a result, they do not incur an "economic loss" if the total paid in interest and principal is equal to or greater than the "purchase" price of the asset.
Although it was done discreetly, news that Athens had opened the fund filtered out and was one of the factors that rattled markets across Europe. At one point Germany's Dax was down 4pc before it recovered. In London, bank stocks - which have been punished by traders nervous about the European debt crisis - fell again. 
In a bid to curb the falls regulators in Italy, France, Spain and Belgium extended their short-selling bans. Although it was designed to support European banks, experts in London reacted angrily to the move, claiming that regulators were wrongly targeting hedge funds. 
Andrew Baker, chief executive of the Alternative Investment Management Association, the hedge fund lobby group, said: "Short-selling was not the reason bank share prices were under pressure and banning it has not relieved that pressure." 
Richard Payne, a finance academic at the Cass Business School in London, ... argued that the moves were an attempt to deflect attention away from the failures of European politicians to come up with convincing solutions to the financial crisis. 
Traders argued that the worsening crisis in Greece was the real driver of market concerns. 
There are particular concerns that the political will to solve the crisis is waning, particularly in Germany. 
Athens' activation of the ELA will raise concerns that Greece will simply shift debt to Brussels. 
The ELA was designed under European rules to allow national central banks to provide liquidity for their own lenders when they run out of collateral of a quality that can be used to trade with the ECB. It is an obscure tool that is supposed to be temporary and one of the last resorts for indebted banks. So far it has only be used in Ireland. 
Regular readers are very familiar with the ongoing run on the Irish banks.
By accepting a lower level of collateral the debt in the ELA is, in theory, supposed to be the responsibility of Greece. However, since the Greek state is surviving on eurozone bailouts and Greek banks are reliant on ECB funding, in practice the loans are backed by the eurozone. The terms of lending and other details are not disclosed publicly. 
Mr Ruparel said: "Though the ELA is meant to be a temporary emergency solution, we know from Ireland, where the programme has been running for almost a year, that once banks get hooked on ELA they rarely get off it."
The reason that banks cannot get off is that no one knows if they are solvent or not.  When there is a lack of confidence in a bank's on-going viability, depositors have an incentive to move their funds to another financial institution.

The solution to restore confidence and bring funds back to both the Greek and Irish banks is disclosure of current asset and liability-level data.  When market participants can analyze this data, they can determine for themselves if the banks are solvent.  This is the low cost path to restoring confidence in the banking system.

Another Telegraph article describes the run on the Greek banks and the need for ELA as follows:
[T]he untold amounts of cash that Greek banks are preparing to help themselves to through Europe's seemingly most generous but mysterious cash machine known as Emergency Liquidity Assistance (ELA). 
This is a liquidity faucet that any national central bank can turn on to prop up its lenders that will otherwise fail. The ECB defines it as support provided "in exceptional circumstances and on a case-by-case basis to temporarily illiquid institutions and markets". 
The Bank of Greece has turned on the flow of funds and all Greek banks stand to receive the emergency cash. 
It could just be a precaution. After all, these Greek bankers are well known for their conservatism. 
But it could also be a sign of the increasing stress Greek lenders are experiencing under the official bail-out terms agreed by the eurozone last month. Rather than post Greek sovereign debt as collateral for emergency funding, the ELA allows lenders to post any old toxic assets in return for cash. It is the lack of disclosure and accountability of the ELA that is of most concern. Its size and conditions are unknown. 

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