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Tuesday, February 28, 2012

A 'selective' Greek default and some emergency liquidity

A few interesting developments overnight and this morning in the eurozone. Specifically, S&P’s decision to put Greece into ‘selective default’ and the ECB’s reaction.

‘Selective default’ is essentially a partial default rating (in this case validly applied due to the current restructuring which Greece is undergoing and the fact that some bonds held by the ECB have been exempted). Under the ECB’s rules, when a country (and therefore its debt/bonds) is classified in any form of default its bonds cannot be used as collateral for the ECB’s lending operations. The ECB released a statement confirming as much this morning.

The kicker here is that Greek banks are completely reliant on ECB lending for their liquidity needs – they could not survive without it. Unfortunately, a huge majority of the assets which Greek banks use as collateral with the ECB are tied up with the Greek state (Greek government bonds or bonds backed by a Greek state guarantee). The plan to deal with this issue is for the majority of lending to Greek banks which currently takes place under the ECB to move to the Greek Central Bank’s Emergency Liquidity Assistance (ELA) programme. The ELA has lower collateral requirements and therefore will presumably continue to accept the 'defaulted' Greek bonds as collateral.

This is an unprecedented move and should stop Greek banks collapsing. That said the opacity and secrecy of the ELA means it will be even harder to figure out what is going on within the massive sovereign banking loop in Greece.

As a refresher, we present an article we wrote last September on the ELA for the World Commerce Review. It provides a comprehensive run down of how the ELA works and what implications its use could have for eurozone.

To read the article see here.

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