E.C.B. Could Survive a Greek Default, but What About the Banks?
Published: September 30, 2011FRANKFURT — The ECB's holdings of Greek government bonds are small enough for it to be able to survive even a large haircut if the country defaults, and its main concerns lie with the impact on the banking sector.
The E.C.B. has spent more than €150 billion, or $200 billion, on peripheral government bonds through its Securities Markets Program, which started in May 2010, first buying Greek, Irish and Portuguese bonds and more recently Italian and Spanish.
Analysts estimate the E.C.B. holds about €45 billion to €50 billion of Greek government bonds it has bought in the secondary market at well below face value, weakening the hit the central bank would have to take in a debt restructuring.
“The E.C.B. by definition has been buying in times of stress, so a rough calculation shows, if they’ve been buying at 70-75 percent (of face value), they would effectively take only a 25 percent haircut,” a Nomura economist, Laurent Bilke, said.
This would mean the E.C.B. would have to accept a loss of around €15 billion to €20 billion from a 50 percent haircut to the face value of the bonds.
“It’s a large amount, but it’s not going to bring the E.C.B. under, it’s not going to go bankrupt,” Mr. Bilke said.
Capital and reserves of the E.C.B. and national euro zone central banks amount to more than €81 billion, the central bank’s balance sheet showed.
The Greek media reported a week ago that Finance Minister Evangelos Venizelos had discussed plans for an orderly default with the International Monetary Fund chief Christine Lagarde and the president of the European Central Bank, Jean-Claude Trichet, as one of three possible scenarios for resolving the country’s fiscal woes.
Officials played down the reports and Mr. Venizelos described them in a statement as an unhelpful distraction from the central task of sticking to Greece’s E.U.-I.M.F. bailout program.
Until recently, European leaders have rejected any chance of Greece defaulting, but are moving to allow for the possibility of this happening.
Klaas Knot, a member of the European Central Bank’s governing council from the Netherlands, on Sept. 23 became the first euro-zone central banker to warn outright of the possibility of a Greek default.
If it comes to a default of Greece — orderly or disorderly — the bigger problem for the E.C.B. would be the systemic risks stemming from such a step.
“It will be very difficult for Portugal and Ireland not to suffer a loss of confidence then,” said Silvio Peruzzo, a Royal Bank of Scotland economist, also pointing to Italy and Spain.
Talk that Europe needs to shore up its banks — if necessary with capital from taxpayers — is gathering strength. The past recession, losses on sovereign debt and higher funding costs are weighing heavily on banks’ balance sheets, and some suggest there should be forced recapitalization by governments if it does not happen otherwise.
The International Monetary Fund reckons Europe’s banks could need to recapitalize to the tune of €200 billion and many bank analysts are far gloomier than the Fund.
To ease stress on banks, the E.C.B. already reintroduced its longer-term, six-month refinancing operation in August and last week joined other major central banks in offering three-month U.S. dollar loans to commercial banks to prevent money markets from freezing up again.
There is now talk of offering longer, one-year liquidity to banks.
Stress in the interbank lending market is already an “indication that the crisis has moved into systemic mode,” Mr. Peruzzo said.
Crippled banks are also likely to leave the E.C.B. holding collateral with little value, but since it accepts all collateral at market value minus a haircut, its losses from this would be manageable — especially since governments would be loathe to let banks collapse as they fear contagion.
Major European banks would probably be able to take such a hit but for Greek banks it could be the last straw.
“Collateral becomes a problem only if Greek banks go under,” Mr. Bilke at Nomura said. “There would be a general issue with Greek banks, they would have to take a big loss and probably some of them would not be able to go through if there’s a big haircut.”
To prevent a Greek default from infecting the whole banking sector, authorities would have to come up with a program to keep banks afloat — and this would have to come mainly from governments, keeping E.C.B. exposure manageable.
So, while the E.C.B. could take the direct losses in its stride, the fear of instability and economic collapse keep it opposing Greek default.
The estimates here could be wrong.
During the GFC, biz media made many speculations and many of them felt that the FED would make huge losses when Bernanke intervened to buy MBS and got involved in TARP & TALF. Yet, in the actual case, Bernanke made huge profits in the aftermath becos he had bought much of those assets at huge haircuts to the collateral.
So the specu-estimate that Trichet purchased Greek bonds at 25% haircuts could be wrong, I would put the figure closer to 50% ( much like what Bernanke 's NY Fed paid for) !!
Another assumption here is that ECB/Trichet would preserve status quo.....
Trichet had sterilised his purchases after buying sovereign debts by issuing ECB bonds to wipe out the liquidity caused by those purchases.
Banks are said to be on the line if Greek defaults due to concerns about liquidty of exposed euro banks...
The conjecture in this article is that ECB may provide liquidty for 1yr refi swap Ops. In fact, there is nothing to stop him from doing QE i.e. printing money like what Bernanke has done... i.e. up the ante and flood the banks with liquidty so that the banking system is propped up.
When in a crunch, liquidity could also come from local govts, France Germany, Austria etc......
This article, is most likely written with the "shorts" in mind - many of whom may think in the worst case scenario of ECB exposure to both sovereign & banks debt, a Greek default may trigger a disorderly panic which will cause the ECB to collapse...
This could be another case of too many assumptions; the firepower of the ECB is a leveraged one if there are plans for Euro TARP or Euro TALF and may not be as "weak" as the article suggest.