European Central Bank Holds Key to Greece's Future

By Brian Blackstone 

        FRANKFURT--A looming bond payment by Greece to the European Central Bank is emerging as the potentially decisive event in the country's attempt to stay in the euro and avoid a banking collapse.
        On July 20, Greece must repay EUR3.5 billion ($3.8 billion) in bonds held by the European Central Bank. The Athens government doesn't have the money and without a fresh infusion from its main creditors--other eurozone governments at this stage--it almost certainly won't have it by then.
        Greece's failure to repay the ECB would lead to heavy pressure on the bank's president, Mario Draghi, from his governing council to no longer accept Greek government-backed debt as collateral for emergency loans to the country's banks. Short of alternative collateral, Greece's banking system would face instant collapse if Athens, the ECB or the rest of the eurozone can't find a workaround.
        If Greece can't finance its banks in euros, it would be forced to sustain them by using a national currency. That makes the withdrawal of ECB liquidity for banks a potential trigger for a Greek exit from the euro.
        A top ECB official signaled the ECB would have little choice but to pull the plug on Greece's banks if Athens fails to pay up on July 20. "That would be a state bankruptcy," Austria's central-bank head Ewald Nowotny said in an Austrian television interview Monday. "In this situation, it would no longer be possible for the ECB to provide further liquidity."
        But how fast the ECB would act isn't clear from officials' statements so far.
        The liquidity Mr. Nowotny referred to is EUR89 billion in emergency loans provided to Greek banks through the country's central bank, the Bank of Greece, subject to ECB approval. On Monday, the ECB maintained a ceiling on those loans that have been in place since June 28. But in a warning shot across Athens's bow, the ECB increased the amount of collateral Greek banks must provide to continue borrowing that much. The move had little practical effect because the banks can meet the higher collateral requirement for now. But it highlighted the ECB's impatience with the lack of progress toward a bailout deal for Greece.
        Eurozone governments have also circled July 20 as the critical date for Greece's future in the euro.
        "The door of the negotiation remains open, but at the same time that door is very conditional and I think we're all running out of time, the latest by 20th of July," Finnish Finance Minister Alexander Stubb said Tuesday on the sidelines of a eurozone finance ministers' meeting in Brussels.
        Greece also faces an additional EUR3.2 billion bond repayment to the ECB on Aug. 20. But July 20 is considered the critical hurdle, because a bailout deal to clear it would likely also cover later debts falling due.
        A debt default on July 20 wouldn't be the first for Greece. The country restructured nearly EUR200 billion of bonds held by private investors in 2012, and it missed a EUR1.55 billion loan repayment to the IMF on June 30.
        Greece "didn't have anything to lose defaulting to the IMF" or restructuring privately held debt, said Jonathan Loynes, economist at London consultancy Capital Economics. "Insofar as the ECB is sanctioning the ongoing support [to Greek banks] on a day-by-day basis, it's a little bit different than the others."
        A default to the ECB would raise additional complications because the ECB's founding charter prohibits it from financing governments. Letting Greece off lightly after a missed repayment would constitute just that in the view of the ECB's more hawkish governors. The central bank's conservative faction is already weary of Greek banks' heavy reliance on central-bank emergency loans and would see a Greek bond default as the last straw.
        The hardest scenario for Mr. Draghi would be if Greece and eurozone governments are approaching a new bailout deal, but don't get there in time for Athens to deliver the EUR3.5 billion to the ECB on July 20.
        The ECB would then face two ugly alternatives: Either cut the banks off and force Greece out of the euro, or give politicians a few more weeks to complete negotiations at the risk of undermining the ECB's credibility.
        The ECB's rules and the Greek bonds it holds contain some flexibility that the bank could exploit, if it wanted to give Athens and its creditors time to complete a bailout deal. The bond contract held by the ECB contains a standard 30-day grace period before nonpayment becomes a legal default, according to people familiar with the technical details of the bonds. But such a technical distinction would do little to alter the view that Athens would be out of money and state-backed collateral worthless.
        The ECB doesn't even need that legal wiggle room, given that the rules governing its Emergency Liquidity Assistance program for banks allow some discretion. Under the program, the loans are granted from Greece's central bank, which takes on the credit risk and has leeway in determining the collateral rules. The ECB's governing council can veto ELA with a two-third majority.
        "The lessons [of Greece's debt crisis] are deadlines are never really deadlines, and just when you think they've run out of options," policy makers find alternatives, Mr. Loynes said.
        The ECB's dilemma is partly one of its own making. It bought the Greek bonds--as well as those of Portugal, Ireland, Spain and Italy--under a limited and temporary purchasing program launched in 2010 aimed at easing tensions in financial markets. The central bank acquired more than EUR200 billion in bonds under this program, which failed to prevent the unraveling of many eurozone bond markets. It still has about EUR20 billion in Greek bonds on its books from that program.
        In 2012, a bolder ECB bond-buying program impressed the markets much more--so much so that the ECB hasn't actually had to activate it. The mere presence of an unlimited program was enough to ease euro breakup fears and prompt a lasting rally in Southern European bond markets.
        Greece, however, remains unable to finance itself on the markets.
        Marcus Walker and Todd Buell contributed to this article.
        Write to Brian Blackstone at brian.blackstone@wsj.com
        (END) Dow Jones Newswires

        July 07, 2015 18:57 ET (22:57 GMT)

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