View the article online at http://citywire.co.uk/money/article/a592011
Greece: the mouse that roared
In the first of a two-part special on the future of the eurozone, Robert Kyprianou examines whether a run on banks could be around the corner.
Working capital shortage
This is what is happening in Greece. Deposits in Greek banks have fallen from €240 billion in 2009 to around €170 billion today. Greece’s economy is collapsing not only because of the lack of competitiveness and bailout funds to pay wages and pensions, but also from a chronic lack of working capital.
The loss of deposits has left the Greek banks on ECB life support. They are awaiting a €48 billion recapitalisation as part of the bailout programme to make up for the losses they suffered on the ill-thought-out PSI 'solution' to the Greek government bond crisis. This recapitalisation is now at risk following the 6 May elections.
And to rub it in, the ECB has stopped providing normal liquidity to Greek banks because of concerns over collateral quality given the outcome of the election. This has forced the local banks to take out Emergency Loan Assistance (ELA) from the Greek central bank estimated at €100 billion.
What ELA means
What difference does it make if the liquidity comes from the Greek central bank or the ECB, you might ask. Liquidity provided directly by the ECB is backed by all members, and the risks shared by all member states. With the ELA, the risks fall fully on the local central bank.
Think about what this says as a statement of confidence by the ECB in your local banks. Think about what this says about the risk of keeping your money in your local bank. No measures – not one – aimed at restoring some hope for the Greek economy or its people will have any chance of succeeding while its banks' balance sheets continue to shrink, and while capital is used up by deposit flight.
This banking squeeze extends beyond Greece. Overnight deposits in Ireland, Portugal and Spain have also declined since mid 2010; Belgium has witnessed deposit flight, especially around the Dexia problems; so too has France. With banks finding it extremely difficult to raise fresh capital, contraction of bank lending and recession follow.
Amazingly, there is little evidence that policymakers in Europe have recognised that the eurozone banking system needs to be rescued first. Instead, a great deal of political energy is now spent in debating growth compacts, or whether to permit a renegotiation of bailout terms, or whether the austerity chicken comes before the bailout egg.
A squabble over austerity is not the real risk to Greece’s membership of the euro. A bank panic may take this out of the politicians' hands. And the real risk of a Greek exit – forced or voluntary – is not to Greece. It is that deposit flight spreads to other member countries with troubled banks.
Could a run on the banks spread?
It might not even require a Greek exit to trigger this contagion. If the deposit flight in Greece were to turn into a panic run on Greek banks, depositors in other countries that are seen as being at risk might also take flight. It may be a small country, but Greece could well be the mouse that roared.
This is why the anti-bailout rhetoric from the radical left in Greece, the main winners from the election, and the threats from German politicians in response are worrying. If Greek households panic and start shoving cash into mattresses, the 17 June election may prove an irrelevance, and those who think this crisis can be ring fenced may be in for a rude awakening.
To save the euro policymakers need to move to shore up the banking system. This requires recapitalising the banks with public funds and making the ECB play the role of lender of last resort. Then maybe, just maybe, fiscal and structural policies together with infrastructure investing will have a chance of restoring growth and public finance solvency to the troubled periphery of Europe.
But as luck would have it, just when strong political leadership is required to steer Europe through its worst post-war crisis, the political edifice is crumbling.
Read the second part of Robert Kyprianou's eurozone feature tomorrow
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by Gavin Lumsden on Oct 21, 2016 at 17:18