DraghiREUTERS/Eric VidalECB President Mario Draghi.
The European Central Bank (ECB) is threatening to withdraw emergency funding from Greek banks if the Greek government doesn't do what it wants.
The central bank's actions toward Greece occur less than two months after secret letters revealed that the ECB threatened to pull emergency funding from Irish banks if the state did not apply for a bailout, in what many saw as an overreach into the sovereign affairs of the country. The ECB later pretended that Ireland had applied for its bailout voluntarily. The letters revealed that in fact the ECB had required the Irish government to apply.
It is one thing for the ECB to require individual banks to follow certain technical rules to maintain their liquidity. It is quite another for the ECB to pressure a government by threatening an entire nation's banks with a sudden default by yanking their liquidity en masse.
That's what is going on now with Greece.
The new Greek government, led by the left-wing Syriza party, is attempting to renegotiate the terms of its bailout deal with the so-called Troika. The Troika consists of the ECB, the European Commission, and the International Monetary Fund (IMF).
Syriza wants a shift in the focus of "structural reforms" toward increasing tax collection and government efficiency and away from crude budget cuts; a "European debt conference" to renegotiate the repayment terms on the country's debt (including linking interest payments to growth and writing down some of the debt); and a reduction in the government budget surplus the country is required to run.
The Troika wants to keep the current deal, which requires the Greek to run a budget surplus (with a target of a 4.5% surplus in 2016) and implement a programme of reforms to bring government debt down from its current 175% of GDP to 124% by 2020.
The country's access to the funding from the central bank that supports its banking system may be cut off at the end of the month unless a compromise is struck. This, at least, is the message coming from members of the ECB's governing board.
SyrizaAlkis Konstantinidis/ReutersHead of radical leftist Syriza party Alexis Tsipras after winning elections in Athens, Jan. 25.
Currently Greece enjoys special dispensation that allows its banks to use Greek government debt and government-guaranteed bank debt as collateral in exchange for funding from the central bank, despite being rated as "junk." This waiver was granted as part of a deal under which the country committed to undertake a package of structural reforms insisted upon by the Troika in exchange for bailout money.
Yet, as Bloomberg reports, ECB Vice President Vitor Constancio told an audience at a conference in Cambridge, England, last week that renegotiation of that deal could put the country's banks at risk. "There will be no surprises if we find out that a country is below that rating and there's no longer a program that that waiver disappears," he said.
If the waiver is withdrawn, then Greek banks will no longer be able to exchange the bonds on their balance sheet for ECB loans. Without that support, the sector could face widespread bankruptcies and could in turn push the country closer to collapse.
Constancio may make it sound as if this is simply a technocratic decision — that the ECB is bound to cut off Greek banks if the country fails to agree a terms with the EC and IMF over its bailout programme — just as it said when it threatened to cut Cyprus off in March 2013.
But that simply isn't the case, according to Professor Karl Whelan of University College Dublin. Instead, he says, this is purely a discretionary decision designed to pressure Greece into making a deal.
He writes (emphasis added):
[Don't] believe for a minute that this is a technocratic thing to do with "the ECB having to follow its rules." And it has almost nothing to do with Greek government bonds being junk-rated. All of the issues discussed above come down to discretionary decisions by the ECB Governing Council (restrictions on T-bills, waivers on junk-rated government bonds, arbitrary lines-in-the-sand on government guaranteed bonds and the mysterious rules of ELA) and there is plenty of wiggle room for them to allow Greek banks to continue receiving various sources of funding next month in the absence of an EU-IMF program agreement.
Greek depositsBank of GreeceGreek bank deposits.
But while the threat is discretionary, the results are very real. In the lead-up to the Greece election, nervous clients of the country's banks began to pull their money out of their accounts at a record rate. In December, depositors pulled €4.6 billion out of Greek banks, taking total deposits to its lowest point since November 2012, and the Greek press is reporting that January saw similar levels of outflows.
As a demonstration of the fears surrounding the banking sector, Greek bank stocks tumbled after Syriza's electoral victory. Investors were clearly worried about the response of the Troika to the new government's pledge to seek a better deal for Greece.
But these fears are forcing Greek banks to be all the more reliant on ECB funding as local sources of capital dry up.
Greek banks ECBMoody'sGreek bank funding mix.

These signs suggests that a number of Greek banks, including the country's largest lenders Eurobank Ergasias and Alpha Bank, may make use of the precautionary lines of credit that they set up with the ECB under its Emergency Liquidity Assistance (ELA). Further doubts surrounding the sustainability of emergency funding are only likely to increase the pace of deposit flight from Greek banks. That is, the ECB may be engineering the very crisis that it claims it wants to avoid.
Why would it seek to do this?
Well, although promoting this type of financial-market volatility may not be an effective way of helping the Greek economy back onto its feet, it has nevertheless proved useful in keeping countries compliant and appears now to be the model of choice rather than of last resort. The longer-term cost, however, may be that these institutions remain more reliant on ECB emergency funding than they would otherwise and much more difficult to rebuild confidence in.
Critics will argue that the central bank is wilfully overstepping its mandate of price stability in the eurozone to meddle in the affairs of sovereign nations. At present, it is hard to find a good argument that they are wrong.