European stocks and bonds dived after the markets opened, but the yields, or interest rates, on bonds from other countries that have been embroiled in the continent's debt crisis—such as Spain, Italy and Portugal—still remain far from the levels seen in 2012 or 2013, when banking problems in Spain and Cyprus raised doubts over the eurozone's integrity.
Greece's decision to call a referendum on the measures its creditors demand in return for more bailout aid has cast the country into uncharted waters. As of Tuesday, it will be cut loose from international rescue loans for the first time in more than five years and is expected to default on a ˆ1.55 billion ($1.73 billion) payment to the International Monetary Fund.
Many economists and officials fear that without further financial support, Greece may have to abandon the euro, causing the first rupture of Europe's currency union.
Speaking after an emergency meeting with top ministers and finance advisers, French President Franc ois Hollande warned that a "no" vote by Greeks on July 5 and a refusal by the Athens government to return to the negotiating table may make an exit inevitable.
"It's a question of knowing whether the Greeks want to remain in the eurozone—which is where they belong in my opinion—or if they will take the risk of exiting," Mr. Hollande said. He stressed that the French economy and the wider eurozone excluding Greece is now better insulated from contagion than at the beginning of the Greek crisis.
"Today the French economy is robust—much more so than four years ago—and it has nothing to fear from what could happen," Mr. Hollande said.
In a preliminary assessment, the European Commission, which oversees EU law, including the free movement of capital, said that Greece's decision to limit access to money stored in its country's banks was justified.
"The stability of the financial and banking system in Greece constitutes a matter of overriding public interest and public policy that would appear to justify the imposition of temporary restrictions on capital flows," Jonathan Hill, the commissioner who oversees financial stability, said in a statement.
"Maintaining financial stability is the main and immediate challenge for the country," he added.
The European Central Bank on Sunday froze emergency loans to Greek banks at their current level of around ˆ89 billion, a move that left Greek authorities with little choice but to keep their banks closed on Monday. Without extra liquidity, Greek banks wouldn't have been able to continue paying out deposits to worried savers.
Much will depend on the ECB's response on Tuesday, the day when the eurozone portion of Greece's ˆ245 billion bailout expires and the government is expected to default on its payment to the IMF. Central bankers from some countries, most notably Germany, have been pushing to reduce the value of Greek collateral needed to secure the emergency loans, which would further squeeze Greek banks.
Banks have to post assets, such as government bonds, as collateral for getting emergency funding from the ECB or their national central banks. When the ECB decides to apply a higher haircut to certain assets, as it has done in the past with Greek government bonds, the amount of liquidity banks can get in return shrinks.
Mr. Hollande said the ECB's Sunday move should keep Greek lenders on European life support until the referendum, but warned that financial risks remain beyond the banking system.
"Today there are uncertainties, notably in Greece, even if the ECB has provided liquidity essential for [banks] to function until the referendum," he said. "There are also worries that can exist on markets. But I want to be clear: Significant measures have been taken in recent months to consolidate the eurozone, resulting in the banking union."
The eurozone now has a centralized supervisor for its biggest banks under the auspices of the ECB and new rules meant to make it easier to impose losses on bank investors without causing broader disruptions to the financial system.
On Saturday, the finance ministers from the 18 other eurozone countries rejected a Greek request to extend its bailout by one month. Such an extension would have helped carry Athens through the referendum.
German Chancellor Angela Merkel would be willing to talk with Greek Prime Minister Alexis Tsipras if he expressed such a wish, Ms. Merkel's spokesman said Monday.
"Of course she is open for talks with Mr. Tsipras if he expressed such a wish," said Ms. Merkel's spokesman Steffen Seibert. But he cautioned that "facts are now on the ground," referring to the referendum decision.
European Council President Donald Tusk, who presides over negotiations between EU leaders, has so far declined to call an emergency eurozone summit, officials say. France on Monday pushed for new talks between Greece and its creditors before the referendum. "Today there is still the possibility of an agreement, tomorrow it will depend on the response of the Greeks in the referendum," Mr. Hollande said.
Other top policy makers have been reluctant to make new support offers to Greece ahead of the referendum.
Spain's Finance Minister Luis de Guindos also urged Greece to come back to the negotiating table before its current bailout expires on Tuesday.
"Under the current bailout deal, we have a big tent we can work with," Mr. De Guindos said. "A new program is always a much more complex thing. The room to negotiate is much easier if there's a deal earlier. If not, there are rules to follow, national parliaments that will become involved."
Write to Gabriele Steinhauser at gabriele.steinhauser@wsj.com and William Horobin at William.Horobin@wsj.com
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(END) Dow Jones Newswires
June 29, 2015 07:00 ET (11:00 GMT)
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