Greece After The No Vote: Four Options For Greek Banking

With Greek voters saying No to the reforms, the countrys most vital challenge is to keep its banks operating. That is manageableprobably, but just barely.

The bank problem is not insolvency, but illiquidity. Insolvency would occur if banks were holding many bad loans. The banks assets, at true value, would not be as great as their liabilities, which are deposits and other obligations. The Greek banking problem, though, is different. There are assets on the books that are probably good, but those assets are not liquid. When a customer comes to the bank to withdraw euros, the bank cannot call in a car loan or a home loan to gain the euros needed to cash out the depositor.

If all the depositors would simply wait, the Greek banks would have no troubles. Depositors, however, are worried that some morning the government will decree that all euro bank accounts are now drachma accounts. The government would turn on the printing presses and the drachma would quickly plummet, leaving Greek bank customers all the poorer. The smart thing to do has been to withdraw euros, and Greeks have been doing this in spades.

A man holds a Greek national flag as he celebrates in front of the parliament on July 5, 2015 .FP PHOTO /IAKOVOS HATZISTAVROU (Photo credit should read IAKOVOS HATZISTAVROU/AFP/Getty Images)

Most central banks, including Americas Federal Reserve, stand ready to provide banks with the liquidity needed to handle runs by depositors. The European Central Bank has provided Emergency Liquidity Assistance to Greece for all of this year. (They work through the Bank of Greece, which is like a middle central bank, between the European Central Bank and the individual banks of Greece.) When a central bank provides this help, it requires collateral. The Bank of Greece has been posting government bonds as collateral. This is the traditional policy. The central bank is typically worried that if private loans are used as collateral, the bank will use dicey deals rather than high quality notes. Thus, government bonds are demanded as collateral because of their safety. (This would be a good time to pause for a laugh.)

Todays problem is that Greek bonds are not considered suitable collateral, so the European Central Bank is about to stop providing liquidity assistance. There are four possible resolutions to the problem.

1. Alternative Collateral. One possible solution would be for the European Central Bank to accept other collateral. However, the liquidity program constitutes a large part of Europes bargaining power, so the ECB may not want to yield.

2. Other Sources of Liquidity. A second possible solutionone which seems unlikely but should be on the tableis for the Bank of Greece to try for a liquidity deal with other institutions. They might shop around for large private banks willing to make short-term loans. Banks around the world have deposits in excess of loan demand, so this approach just might work if the collateral is good enough.

Source: http://www.forbes.com/sites/billconerly/2015/07/05/greece-after-the-no-vote-four-options-for-greek-banking/