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Ptochotrapezocracy, or rule by bankrupt banks, is a term used (and, as far as I can tell, coined) by Yanis Varoufakis to describe the system of capitalism post-crisis [1]. While the European council applies itself to the task of apportioning blame for the clusterfuck that is the Greek debt crisis (though now it seems the Council President Donald Tusk wants nothing to do with the mess) it seems to me that policy in and around Greece will in the next days and weeks be determined by the state of the Greek banks, with all concern for “Europe” thrown to the wind in the face of more pressing demands.


A summary of the argument below the fold:

  • Lifting trade credit and import restrictions should be a priority for the Greek government, more than lifting restrictions on cash withdrawals
  • The greek banks are still solvent, but the ECB won’t allow ELA to be relaxed for the purpose of financing imports unless the ongoing bank run is stopped
  • The bank run can only be stopped by freezing deposits until the economy is stabilised, as done in Cyprus two years ago
  • If the ECB pulls ELA entirely, in addition to a deposit freeze there will have to be a deposit haircut, of maybe 35% of the €65bn of domestic time deposits (€60bn of domestic overnight deposits would be preserved, but frozen)
  • In order to avoid a bail-in of deposits even in the event of a recapitalization, the ECB’s supervisory arm SSM should have restructured the banks as early as February 4, when in fact the ECB shifted half of its liquidity provision to ELA
  • This is because €31bn of liquidity flowed out of the Greek banks in the month of January, the worst month of the 9-month bank run

In my opinion, the number one priority of the Greek government should be to restore access to central bank liquidity for the Greek Banks, because the so-called “negotiations” with Greece’s creditors on a “rescue” are all fun and games until someone gets hurt, and when trade credit is impaired things get real.

Trade restrictions is where it gets real

There has been no shortage of stories in the press in the last couple of weeks about difficulties importing essential goods, from food to pharmaceuticals but what does real lasting damage to the Greek economy is the effect on exporters. Like most countries today Greece is integrated in the global supply chain, which is a way of saying that Greek exports are dependent on imported intermediate goods. So, when bank illiquidity impairs trade credit for imports, exporting businesses grind to a halt.

The picturesque region of vineyards beyond Thessaloniki is famous for its wines and spirits that are in high demand across the world, regardless of Greece’s economic crisis. “But in order to sell wine abroad, we need bottles to put the wine in,” sighs a despairing Emmanuil Vlachogiannis, vice president of Thessaloniki’s chamber of commerce.

“We don’t make bottles in Greece, we import them. But with capital controls and a freeze on the banking system, imports are practically nonexistent, so the bottles aren’t coming in. No one can export wine without bottles. We’re experiencing a devastation of the economy. For one week nothing has moved, there are no transactions.”

The export sector includes the tourism industry, and that also requires imported intermediate goods:

Tourists are still flocking to Greece, and the services provided for them haven’t changed – foreign visitors are exempt from the cashpoint limits. But Yannis Kokkinos, who runs a Thessaloniki-based swimming pool construction firm, said: “We’re unable to provide the most simple service to our clients — they might need a small part for a filter or a pump that costs €30 or €40 for us to bring in from Spain, England or Turkey. But we can’t make a foreign transaction.”

The problem is not just the loss of current business, it is the loss of customer relations as, in the future, customers will buy goods and services from other countries than Greece.

So, while domestic cash restrictions may be painful right now, import restrictions are damaging for the future. After all, there are reported to be €45bn in Euro banknotes in Greece, that is, about 25% of GDP, which is more than enough to keep the economy running even without access to ATMs. And, for that reason, it should be the government’s priority to resolve the bank situation as soon as possible. This means convincing the ECB to lift the cap on bank liquidity, which at this point requires a bank restructuring. Jens Weidmann made that clear in a speech last week at a Bundesbank event:

In the event that further short-term assistance is thought to be desirable or necessary, it is up to fiscal policymakers to provide ad hoc financial support.

Greek bank solvency

But why would Greek banks need fiscal support? On paper, they are solvent (see the equity capital below), but they have a liquidity problem. From the end of September 2014 (when Bank of Greece funding was at a low of €43bn) to the end of May, the Bank of Greece had to increase its liquidity support by about €74bn (the reported size of ELA financing at the end of May) to compensate for a combination of deposit flight and loss of foreign interbank financing.

Greek banks: aggregated balance sheet October
to May
Assets Liabilities
on BoG €2bn €116bn to BoG +€74bn
Domestic €236bn €139bn Domestic -€43bn
Euro area €53bn €8bn Euro area -€6bn
non-Euro €50bn €33bn non-Euro -€27bn
Fixed €4bn €2bn Debt securities -€1bn
Derivatives €4bn €7bn Other financial +€2bn
Interest €2bn €15bn Other -€1bn
Other €41bn €41bn Loan loss provisions +€4bn
€29bn Equity capital -€5bn
Total €391bn Total -€3bn
As of end of May 2015
Source: Bank of Greece

The issue is that the Bank of Greece liquidity is given against collateral. During the month of June, Bank of Greece liquidity was increased by between €15bn and €18bn, bringing the total to some €135bn, 2/3 of which Emergency Liquidity Support (ELA) given by the Bank of Greece against Greek collateral, and the 1/3 against collateral that the ECB acepts for its regular liquidity provision (Note the sizeable “Euro area” and “non-Euro” assets above, which include €38bn of Euro area securities and €19bn of non-Euro securities presumably of high quality). In any case, the ECB has decided that the available collateral is not good enough to continue increasing the liquidity support, and it’s not just Jens Weidmann that is taking a hard line on the continuation of ELA:

Bank restructuring

Since the ECB has indicated it will not increase liquidity provision and may even withdraw it altogether, if the Greek government wanted to at least lift the import restrictions it would need to stem the bank run.
I don’t believe for a minute the following is a realistic expectation, especially after the events of this weekend:

“We are preparing to open up branches for normal banking services next week. Capital controls will last for a while but not for as long as in Cyprus. The situation is very fluid but we don’t think we will need a major recapitalisation of the banks,” said the source [“a top Greek banker close to the talks” with the creditors].

An estimated €40bn of money stashed in “mattresses” should flow back into deposits as confidence returns. …

The bank run is not going to abate by itself “soon”, as confidence is not going to return. And, to go by the statements of various central bankers, confidence would need to return before the ECB is ready to authorise lifting cash restrictions. Not to speak of the confidence of foreign lenders, which have also been “running”. To get an idea of what’s involved here let’s expand the upper half of the above balance sheet (with estimated current figures).

Greek banks: estimated balance sheet October
to June
Assets Liabilities
on BoG €2bn €134bn to BoG +€89bn
Domestic, of which
Government securities
Greek, of which:
Financial sector
Nonfinancial sector
Euro area, of which
Nonfinancial sector securities
EZ, of which:
Financial sector
Nonfinancial sector
non-Euro, of which
Nonfinancial sector securities
non-Euro, of which
Financial sector
Nonfinancial sector
Fixed €4bn €2bn Debt securities -€1bn
Derivatives €4bn €7bn Other financial +€2bn
Interest €2bn €15bn Other -€1bn
Other €41bn €41bn Loan loss provisions +€4bn
€29bn Equity capital -€5bn
Total €391bn Total -€3bn

Stemming the bank run requires preventing any further drawdown of the “Domestic”, “Euro-Area”, “non-Euro” and “Debt securities” liabilities by making them permanently or temporarily non-redeemable. In other words, restructuring the banks. Although domestic nonfinancial sector deposit account for only half of all the outflows of the past 9 months, they represent 75% of the remaining liabilities susceptible to a run. The non-Euro money market financing, on the other hand, has flowed out almost completely, accounting for about 1/4 of the outflows but a negligible fraction of the remainder.

This means that what is caught out is mostly €123bn of domestic nonfinancial sector deposits, unfortunately, followed by €27bn of non-Euro nonfinancial sector deposits, and €6bn of Euro-area money market funding.

Deposit freeze

One way to open the banks without imposing a haircut on the domestic deposits might be to “freeze” them by converting some fraction to time deposits with no early redemption option. Future income flows would be paid into regular deposit accounts that people would be able to draw freely. This would be a mild form of bail-in because it would entail no loss of nominal value of the deposits, just a liquidity freeze, and it would allow import restrictions to be lifted which is a prerequisite for the economy to recover so the deposit freeze can be released. Something similar was done in Cyprus in 2013. The Cypriot capital controls were lifted after two years, when about 1/2 of the ELA balance owed by the Cypriot banks to the Bank of Cyprus had been repaid. This was starting from about 70% of Cyprus GDP, compared with Greece ELA which is currently about 50% of GDP. So, the Greeks could see their deposits frozen for some 18 months, assuming the economy stabilizes until then.

Deposit haircut

Painful as this seems, it still does not require a recapitalization of the banks, which would be necessary if the ECB recalled the ELA funding. Since the Greek government is broke, the ESM bank recapitalization fund would have to get involved, in exchange for macroeconomic conditionality (a “memorandum”). Here one would expect the creditors to demand actual losses on the holders of Greek bank liabilities which as we noted, is about 75% domestic deposits.

To minimize the haircuts, the following could be done. First, liquidate the €38bn of non-Greek Euro securities and the €19bn of non-Euro securities on the asset side the the banks’ balance sheet, to repay some of the central bank borrowing. This would still leave some €77bn of Greek ELA to be repaid. The ESM might demand something along the following lines: bailing in bondholders for €2bn and non-Euro deposits for €29bn, leaving €46bn to make up for. Of these, half (€23bn) would be ESM capital that would go immediately to repaying ELA, and €23bn of bailed-in domestic deposits. That’s a €23bn haircut (35%) to take from the €65bn of domestic time deposits. There are €59bn of overnight deposits which would be preserved but “frozen”.

Greek banks, post bail-in
Assets Liabilities
on BoG €2bn €54bn BoG ELA
Domestic, of which
Government securities
Greek, of which:
Nonfinancial sector
Euro area €15bn €7bn Euro area
non-Euro €31bn €7bn Other financial
Fixed €4bn €15bn Other
Derivatives €4bn €41bn Loan loss provisions
Interest €2bn €23bn ESM capital
Other €41bn €23bn
bailed-in deposits
bailed-in non-Euro
bailed-in debt
€29bn Old Equity capital
Total €334bn Total
Hypothetical restructuring

The bailed-in capital would be in the form of equity, preferred shares, or CoCos. Note that still no losses have been recognised on the asset side, because the reason for the restructuring is the recall of as much ELA borrowing as possible. With this balance sheet, the Banks’ infamous Deferred Tax Assets (which make up most of the €41bn of “other assets”) could be wiped out, improving the fiscal position of the Greek government. In addition, the creditors would insist on “dealing with nonperforming loans” which would require recognising losses on the €208bn of domestic loans. These two interventions would consume the “Loan Loss provisions” on the liability side, and a substantial fraction of the capital, almost certainly all of the old equity capital and some of the bailed-in capital.

Could this have been avoided?

One question that arises from all this is what could have been done differently to avoid arriving at a situation where domestic time deposits need to be bailed in. To answer this question, consider: we have assumed the €23bn of bailed-in domestic deposits match €23bn of ESM capital. In order to have avoided this outcome, banks should have been restructured when the central bank liquidity provided to the Greek banks was €46bn less than it is now. Currently one can estimate BoG liquidity at €134bn, so the banks should probably have been restructured when “Liabilities to the BoG” were equal to €88bn. But this was at the end of January according to the Bank of Greece. This means that on February 4, when the ECB wrote

  • ECB’s Governing Council lifts current waiver of minimum credit rating requirements for marketable instruments issued or guaranteed by the Hellenic Republic
  • Suspension is in line with existing Eurosystem rules, since it is currently not possible to assume a successful conclusion of the programme review
  • Suspension has no impact on counterparty status of Greek financial institutions
  • Liquidity needs of affected Eurosystem counterparties can be satisfied by the relevant national central bank, in line with Eurosystem rules

the ECB should not only have shifted about half of its then-current liquidity to ELA but also frozen it, having the Single Supervisor SSM initiate a restructuring of the banks. This is because fully €31bn (that is, 1/3 of all the central bank liquidity provided to Greece in the past 9 months) was given in the month of January alone.

But consider the timing of this. Late December Syriza forces and election, which it wins on January 25. After just 10 days, with the Greek government just sworn in, the ECB caps liquidity to the Greek banks, forcing capital controls but early enough to make a bail-in of domestic depositors unnecessary. Contemplate the politics of that move, when as it is (shifting liquidity to ELA but not capping it) was described by Karl Whelan as “ECB in politicised mission creep while helping trigger a bank run”. I’m fully on board with Karl Whelan on the politicised mission creep, but the bank run was already past its peak when the ECB took its February 4 decision.


[1] Good riddance 2010, Welcome 2011 (December 31, 2010)
—: The Road to Bankruptocracy: How events since 2009 have led to a new mode of reproduction (March 2, 2011)

  1. Anonymous permalink

    Just made some calculations using the same source as you … not sure, but I would have thought RWAs would go down too, with assets liquidation, unless zero risk weight of course.

    Would you mind taking a look?
    Will send a link via twitter.
    Thank you,

  2. The EU’s logic is circular, Greece is illiquid because it is cut off from the flow of external funds, which cannot be offered because Greece is too distressed … because it is illiquid.

    This is politics rather than economics. A simple management decision would allow funds to flow while manager figure out how to solve the longer-term liquidity — and ‘other’ — issues.

    As for the ‘intermediate goods’ the issue is not wine bottles or parts for hotel laundry machines but the flood of petroleum flowing into Greece every single day in order for the country to keep its precious fleet of useless, non-remunerative automobiles running in aimless circles.

    This flood must be paid for with trillions of euros borrowed from giant euro- issuing banks: DB, Soc-Gen, etc. The actual returns to the users on this transaction are nil, maybe 5% of fuel use is remunerative, the rest is for ‘lifestyle/entertainment purposes, only’.

    At the end of the day, the European has no fuel — he has burned it up –, he also has no return for the waste of the fuel; he has insurmountable debts which can never be repaid only diluted with more debt. The spent fuel circles over our European’s head in the form of toxic gases … like a vengeful god,

    Greece is utterly bankrupt … so is Germany. The financial and energy structure for both countries is identical, Both use a foreign currency. Germany is actually worse off b/c its precious ‘products’ cannibalize value and destroy capital everywhere they are put to use.

    National suicide … how the banking system (dis)functions in detail is truly rearranging the deck chairs on the Titanic.

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