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Just a small post on the newly released June monthly statement by BoG:

BoG monthly statement June 2015

The large increase in central bank lending to Greek banks is quite evident: BoG loans were used to finance increased banknotes hoarding (+€5bn in a month) and deposit outflows (+€7.5bn). This increase stretched posted collateral which reached close to €200bn. Given that debt securities and credit claims held by Greek banks amount at a bit less than €300bn (with around €18bn being securities in currencies other than the Euro) with a significant part encumbered in various covered bonds and other securities it is obvious that banks were running out of available collateral and capital controls were really around the corner as long as ELA financing needs did not decrease. Obviously the increase in haircuts at the 6th Jule meeting only made matters worse. Based on the above numbers it is clear that it will be extremely difficult to relax capital controls without cash/deposits returning to the Greek banking system.

Another interesting observation is the extremely low figure for the government account which amounted at only €600mn. This reflects the large effort by the Greek government to keep paying official creditors during 2015 and the slow deterioration of state finances due to the ongoing recession. Since ELA was capped before the end of June the above figure suggests that the Greek government was in no position to pay the IMF on 30 June even if it wished to do so (since it could only use funds available at the BoG). Its financial position was extremely stretched and it would have to quickly decide whether to resist creditor demands by issuing IOUs or accepting the terms of a new bailout.

Even if government entities still had funds in bank accounts that could be tapped by the central government, the ELA cap made transferring them to the government account held at BoG close to impossible. These funds might be able to help in domestic payments to government employees and pensioners but would not allow paying (principal and interest on holdings of) foreign debtholders making Grexit very likely in order to avoid a general default on government debt.

One last issue that I don’t see people touching often is the fact that the very large ELA amount will result in significant windfall profits for BoG during 2015 which will be remitted back to the government. Assuming an ELA spread of 150bps over the MRO rate (BoG has to pay the MRO rate on its liabilities towards the Eurosystem), BoG should have already earned an amount close to €450mn in profits (although a part will probably be set aside as provisions). These profits might prove significant for the 2016 state budget execution.

Since the governor of the Bank of Greece asserted that almost €20bn in deposits have returned to the Greek banking system, I ‘d like to take a brief look at recent deposit developments, based on the relevant BoG statistics.

If one takes a closer look at deposits breakdown the data show that, since June 2012:

  • Government deposits have increased by €8.8bn, mainly due to inflows from the EFSF loans.
  • Domestic private sector deposits have increased by €13.5bn.
  • Non domestic residents deposits fell €6.5bn (almost €4bn since January).

Using the ‘liabilities to the Eurosystem due to banknotes’ component of the monthly BoG financial statement the result is that almost €10bn   of the increase in private deposits can be attributed to a reduction in banknotes held by the general public. As a result, it seems that only limited actual deposits inflows from abroad have happened, which were negated by the outflow of deposits of non residents. All in all, since June 2012 total deposits grew €15.9bn, a bit less than the effect of EFSF loans and lower banknotes demand combined.

Although Greek households have returned ‘vault cash’ back to banks, the same does not seem to have happened to deposits held abroad. Since current ‘excess’ banknotes are close to €12.4bn, any reduction in Eurosystem liabilities for the Greek banking system in the future will be limited.

Bank of Greece released the September 2012 balance sheet data. These clearly point to stabilization. Lending from the Eurosystem was €30.26bn (€30.86bn in August) while ‘Other Claims’ €100.64bn (€100.83bn in August). What actually changed substantially was the collateral posted, with collateral for regular Eurosystem refinancing operations registering at €32.72bn (down from €33.04bn in August) while ‘Other off-balance sheet items) were €222.40bn, compared with €235.44bn in August, a total drop of €13.36bn to €255.12bn. Although the drop in financing was not significant, the improvement in collateral posted was, easing financing conditions for domestic credit institutions.

On the liability side, banknotes were the main source of low demand for central bank liabilities, with net liabilities (to the Eurosystem) dropping to €16.43bn, a drop of €1.12bn from the August figure of €17.55bn. Liabilities related to Target2 remained almost unchanged at €107.84bn. Other liabilities such as government deposits and credit institutions bank reserve accounts were roughly steady.

Overall, it seems that any improvement on the liability side is mostly related to the general public re-depositing excess banknotes held outside of the banking sector, rather than to inflows of liquidity from abroad. The general yield drop during September (including Greek government bonds) allowed Greek banks to lower collateral posted to BoG significantly. In my view, these developments although positive, only lower the general stress of the banking sector and have limited potential for further improvements. What is needed is a substantial drop in Target2 liabilities, driven by capital inflows something which is rather difficult right now.

There’s a lot of talk lately (again) about a possible Greek exit from the Euro in the near term future. Personally i find such scenarios a bit extreme since i cannot really think of many ways were Greece can actually be pushed to exit the Eurozone.

Regarding outstanding government debt, this can now be broken down in four categories. Loans from the Greek Loan Facility and EFSF, post-PSI government bonds, T-Bills and bonds held by the ECB. Based on Bloomberg data the post-PSI bonds outstanding amount is €62.4bn while T-Bills stood at €15bn in June 2012 (they were increased during August in order to pay ECB maturing debt).

The post-PSI bonds do not pay principal until 2020 and current coupons are only 2%, meaning that annual interest cost is only a bit more than €1.2bn. That is equal to a typical T-Bill auction reflecting the fact that the costs are easily financed by the existing T-Bill issuing mechanism. T-Bills are mostly held and rolled over by the Greek banking system, with a bit of help from Bank of Greece ELA financing. Consequently, all of the Greek tradable debt securities can be assumed to be ‘safe’ in the near-term. Loans and EFSF notes also only pay interest for now. The budget primary deficit has dropped significantly and based on Bank of Greece data till July it was only €2bn.

As a result, the main risks regarding debt refinancing include:

  • ECB held bond redemptions.
  • Interest payments on Greek Loan facility debt.
  • Covering the primary budget deficit.

Even if Greece were to default (in one form or another) to its payments to ECB, it would be legally challenging for the latter to consider this as a general default event and not allow Bank of Greece to accept government paper in ELA financing. Covering the budget primary shortfall can be managed by a couple of large T-Bill auctions while the latest €11.5bn packet is expected to turn the deficit into surplus by next year. My view is that European countries will not risk calling a default on their loans and will continue to service their interest payments through the escrow account. All in all, debt financing seems hard to become a trigger for an exit event.

The main risk in my view is covering euro outflows through ELA financing. Possible triggers are:

  • Reaching a ECB imposed limit on ELA financing with the ECB choosing not to increase BoG limits (and the latter honoring them).
  • Having the banking system run out of available collateral to post to the BoG.

According to the latest BoG balance sheet data, Greek banks have pledged at least €250bn in assets. Based on ECB data ‘total loans to other euro area residents’ in Greek banks balance sheets stand at €240bn while holdings of securities are at €41bn and remaining assets at €43bn (i am not so sure how much of the €64bn external assets can be used). It is clear that the situation is very tight and a small shock can push the system to its limits, especially since most of the remaining assets are valued much lower than par. Still, BoG can do accounting gymnastics and use government guarantees in order to value collateral much more favorably than their fair/market value.

Having the ECB set a hard limit on any of the BoG refinancing operations will basically transform the Eurozone from a monetary union to a fixed exchange rates area. Although it is probably theoretically possible, it is very difficult from a legal point of view (especially since BoG retains the risks of ELA and only provides collateralized loans) since it surely does not promote financial stability (but rather is used as a mechanism to protect the Eurosystem balance sheet) and will obviously introduce a huge risk in the Eurozone. Any holder of euros in a periphery country should try and ‘exit first’, before a possible ‘ceiling’ on outflows is reached, something which is not possible now given the unlimited overdrafts in Target2 liabilities of NCBs.

In summary, i believe that any exit will basically be the result of tight political negotiations and agreement. The ability of the rest of the Euro countries to actually push Greece out of the Euro (especially without risking full contagion in Spain and Italy) is extremely limited in my view.

Bank of Greece finally released both May and June balance sheet data and is no longer out of sync with the rest of the Eurosystem NCBs in its release schedule. The following table outlines the most important entries in data since April:

The most obvious fact is that during May (the month of the first Greek elections) all of central bank lending was moved to ‘Other claims’ (ELA), something which clearly made things much more difficult for Greek banks. It is clear that MFI lending is still on an increasing path, fueled by banknote demand and euro outflows to the rest of Europe (which is recorded as increased Target2 liabilities).

Total liabilities to the Eurosystem are now over €128bn, a number which will probably exceed 60% of 2012 GDP. Coupled with official lending through the EFSF and the Greek Loan Facility as well as the ECB SMP portfolio, official liabilities are more than €250bn (over 125% of GDP), effectively subordinating the English law new Greek bonds. I really don’t see how Greece will be able to maintain this kind of net negative position without defaulting, probably to the ECB, which should be considered the largest ‘creditor’ of Greece.

Although collateral for ELA also includes a few billions which were present before the summer of 2011 (when ELA was activated for the Greek banking system), still the total collateral pledged to Bank of Greece is just enormous. According to the latest Greek banks balance sheet data, the banking system includes €254.8bn in credit claims, €68.2bn in securities, €18.3bn in shares and other equity and €35.9bn in remaining assets. Coupled with the fact that interbank loans are actually negative about €27-30bn, total (pledgable) assets are less than €350bn, with almost €270bn already pledged at the Bank of Greece. Even with extremely low haircuts of 20%, Greek banks are basically out of collateral and only continue to function on the life support of ELA and government guarantees. Completion of recapitalization using EFSF notes is urgently needed. Even then, i am not sure how the banking system can withstand any more loan write-offs and capital flight. My feeling is that Greece will face another ‘moment of truth’ in September with a default or euro exit quite probable, especially if the economic situation (and outflows) does not improve quickly.

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Kostas Kalevras

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