19th April 2010 by Shaun Richards
Last week was another in a sorry saga for Greece and her finances. We returned to our “groundhog day” scenario where Greek government bond yields rise which politicians respond to with promises and then after only a few days the flaws in the promises become evident and then Greek bond yields rise again. Each time this scenario has played out Greece has emerged weaker than the time before. Yet none of the main players in this saga seem to have the foresight to try to break this repeating cycle.At the end of last week Greek government bond yields had risen to as high as they have been during this crisis. However just to add to the potential problems I saw that the Reuters news agency was reporting that the President of the European Central Bank Mr. Trichet was saying that Greek banks were in difficulties.
What did he say?
“Despite the commitments expressed in the statements by the euro area heads of state and governments on 25 March and Eurogroup on 11 April and the determination signalled by the Greek government to implement the announced adjustment measures for 2010, financial market tensions are persisting.”
He goes on to say that the European Central Bank (ECB) and the national central banks are providing liquidity to the Greek banking system and that recent changes in collateral rules had removed the risk that banks would not be able to use Greek government bonds as collateral for loans at the ECB. Then came the most revealing part of his statement.
“Still the liquidity situation of Greek banks remains difficult and could deteriorate”
For a statement from a President of a central bank this is important. It is quite rare for such a person to discuss the failings of his/her political masters but it is even rarer to discuss banks under your system being in difficulties.
What does it mean?
Such a statement can only mean one thing that money is flowing out of the Greek banking system and presumably at a fair old rate. When I saw it I thought of the circumstances which would make me talk like that if I was a central bank president and there were two. The first was if someone was removing my teeth without anaesthetic and demanding the information (the film Marathon Man comes to mind) and the second was that such a drain was already underway and talking about it could do little extra harm.
There is an irony about this. You see ordinarily such a bank drain involves switching money into another currency.However we now hit a fact that the founding fathers did not intend when they were trumpeting the euro’s advantages as a single currency for Europe. Depositors can remove their money and re-deposit in another country in another bank and keep their money euro denominated. There are sixteen countries in the euro zone so there is plenty of choice if one should wish to move from the Greek banking system to an alternative. So there you go a run on the bank is actually relatively easy and without currency risk in the euro zone.
What might have caused it?
I suspect that people have been looking at the system for insuring bank deposits in the euro zone and fretting at the flaw in it. You see the insurance is national but monetary policy and central banking is supra-national. Whereas in the UK and US the two things are joined. For example everybody knew that when the Bank of England guaranteed Northern (c)Rock deposits it could in the extreme print money if necessary.
In the case of Greece depositor insurance is provided by the national government. This is the same national government which has fiscal deficit and solvency troubles. The deposit insurance system relies on national liquidity and solvency just at the time it is weak.If you were a depositor in a Greek bank it is not so unreasonable to worry that if a bank failed the Greek government would struggle to find the funds to bail out the bank and it is not so unconceivable it would fail to do so.
Now there are two clear cases here. The first is for those with deposits up to the Greek limit and the other is for those above it so let me explain what it is as many seem to be discussing this subject without referring to this.
The Hellenic Deposit Guarantee Fund
The maximum level of cover per depositor is 100,000 and it was raised to this level for a term of 3 years in the autumn of 2008 as a response to the financial crisis from its previous level of 20,000 euros . However,the cover offered by the deposit guarantee schemes of some Member States, such as Ireland is higher and many of the other countries are more solvent and liquid so they would be more able to pay out. I would suspect that currently investors minds are likely to be focused on who would be the most likely to be able to pay out.
Whilst the fund does have money one suspects that in the event of a systemic failure then it would run out just like the financial services compensation scheme did in the UK (it was backed up by the UK government and levies to it have been raised to help repay this). So those with deposits of less than 100,000 euros do have protection but the scheme would have to call on the Greek government for a systemic failure.
For those with deposits above 100,000 euros then other governments have set an example which Greece might wish to follow but sadly cannot afford. For example in the UK the credit crunch has seen all retail depositors paid out regardless of size and including those with deposits over the compensation limit in the UK. There has been debate as to how long the UK could have done this for whereas it is hard to conceive of Greece in her current situation affording this at all.
Whilst Greece has raised her deposit insurance scheme levels during this crisis to above the minimum levels required by the euro zone I suspect that the real issue on the mind of retail depositors must be her ability to actually pay out. This would be added to by the fact that up until 2008 payments into her deposit fund were to support a scheme that was only offering one fifth of the protection it is offering now. So the slack would have to be taken up by the Greek government,which of course is the same Greek government which is beginning to struggle to fund herself at any sort of economic rate.
One solution would be for the deposit insurance scheme for the euro zone to be supra-national and run by the ECB. This would require some way of financing this as we hit the problem of fiscal policy being independent in each of the eurozone currencies. It would also require the signature of nations less likely to benefit from the scheme such as Germany.
The ECB has no choice but to supply as much liquidity as the Greek banking system requires. There would be no harm in publically stating this and it should get the euro zones politicians to speed up their rescue plan as delay is becoming ever more dangerous.