Capital flight out of Greece is in full swing. People are hoarding euro cash under the mattress, squirrelling it away or packing it into suitcases to bring it out of the country. Most of all, wealthy Greeks, banks and international investors are issuing payment orders to banks abroad, as long as this is still possible. In December 2014 alone a net 7.6 billion euros, equivalent to 4.1 percent of Greek GDP, was transferred abroad, generating the largest rise in Greece’s Target liabilities to the European Central Bank (ECB) since May 2011. The exodus of capital must have increased significantly as the new year started, spurred by the latest election results, and in particular now, after the new Greek government met a cool response in every European capital to its demands for more fresh money.
While Greece’s Target balance for January has not yet been released, the German Target claims on the ECB have: they increased by 55 billion euros during the month, the third-largest increase since the outbreak of the financial crisis eight years ago. This signals a huge capital flight towards Germany. The incoming capital can have many provenances, but a sizeable portion of it is likely to come from Greece. This calls for taking heightened care that what happened in Cyprus won’t be repeated here.
In 2012, Cyprus was in a similar bind as Greece today. As wealthy Cypriots and foreign investors, mainly German banks, Russian oligarchs, and Athens and London investors, tried to whisk away their money to safer places abroad, the Cypriot central bank created 11 billion euros worth of new money, equivalent to 60 percent of GDP, in order to keep banks solvent despite the relentless avalanche of payment orders. This kept the capital flight going, since without those funds the banks would have fallen into insolvency and the money could not have fled the country.
The Cypriot central bank resorted to an emergency mechanism of the Eurosystem called Emergency Liquidity Assistance (ELA), under which it may grant credit to the commercial banks in its jurisdiction in acute danger of becoming insolvent. The ECB gave Cyprus generous time to conduct such operations: as it turns out, ELA credit can only be stopped by a two-third majority in the ECB Governing Council, and the six crisis-afflicted countries, which have all faced similar straits, had at the time commanded one vote more than one third. Thus, the blocking majority to stop ELA could not be reached. Only in spring 2013, when the abuse was too large to ignore, the ECB pulled the plug. This pushed the Laiki Bank into insolvency, despite the 9.5 billion euros it had received out of the 11 billion-euro ELA credit given by the Cypriot central bank, forcing Cyprus to erect capital controls to stem capital flight. These controls are still in place. As the then president of the Cypriot central bank, Panicos Demetriades, admitted during a press conference, the insolvency of the Laiki Bank had been delayed with the emergency credit from the Eurosystem in order to keep things calm until the elections were over.
This would not be so explosive if the money orders did not automatically lead to the other central banks in the Eurozone providing cover. After all, it was the Bundesbank and the other Eurosystem central banks that credited the funds to the new accounts filled by the fleeing investors and banks, in the process effectively granting credit to the Cypriot central bank. As a counterpart to this credit, they received interest-bearing Target claims on the ECB system. Without the help of the ECB system, the capital controls would have had to be set up one year earlier.
To redeem the ELA credit, Cyprus later received 10 billion euros from the rescue programme put together by the parliaments of the Eurozone countries. The Target balances and the ELA credit decreased automatically, in the same measure as the rescue credit led to payment orders to Cyprus. The ECB Council first puts the taxpayers on the hook, and then parliaments have no other option but to haul them out.
The ECB declared before the German Constitutional Court that the ELA emergency credit posed no problem at all, since it would be the Cypriot central bank itself that would bear the liability and not the remaining Eurosystem central banks. Alas, this was not quite so, since the volume of the emergency credit far exceeded the Cypriot central bank’s capacity.
Normally, the Eurosystem central banks pool the losses resulting from credit that they have given to commercial banks out of self-created money. In the case of non-performing loans, they all receive correspondingly lower interest income and can therefore transfer less profit to their respective treasuries. In the case of ELA emergency credit, however, the liability falls upon the issuing central bank itself: in case of non-repayment of such credit, it will receive permanently lower transfers from the pooled interest income resulting from credit granted by the Eurosystem.
There is a natural limit to this liability, however: it is hit when the potential loss of interest income associated with the failing ELA credit equals the interest income that the national central bank would normally receive from the pool of credits granted by the Eurosystem. Beyond this limit, liability is simply no longer feasible and the national central bank in question should actually fall into insolvency, since it may not meet its interest obligations towards the remaining central banks by resorting to the printing press. Since the sovereign of that national central bank is under no obligation to replenish its capital and is not liable for the losses incurred by it, the liability for the excess portion of the ELA credit falls inevitably upon the remaining national central banks in the Eurosystem. They must bear all losses that exceed the capacity of the national central bank in question, receiving as a result lower income from the interest pool, since part of this income no longer exists.
The liability limit corresponds, when the stock of central bank money remains constant, to the sum of a national central bank’s share in the overall stock of central bank money in the Eurosystem plus its equity capital. At the peak of its crisis, in April 2013, Cyprus had exceeded this limit by 244%. The uncovered portion of its ELA emergency credit amounted at the time to 8.1 billion euros, or 45 percent of its GDP. The situation is not yet as extreme in Greece, but it is heading that way.
Last week, the ECB Council prohibited the Greek central bank to issue money and lend it out to the commercial banks in its jurisdiction if that money was collateralised only with state-guaranteed promissory notes of the banks themselves or with Greek government bonds. The access to the national printing press had apparently been used up already, in order to finance the capital flight of wealthy Greeks, banks and international investors. To compensate for this, the ECB Council allowed the Greek central bank to grant up to 68.3 billion euros in ELA credit to its commercial banks.
This sum far exceeds the liability limit. After all, the Greek central bank “owns” only 38 billion euros of the central bank money in the Eurosystem, in the sense that it is entitled to the interest income resulting from the credit that this money stock represents. In addition, the Greek central bank’s equity, including valuation reserves, amounts to 3.9 billion euros, the returns to which it is also entitled to. Since both these items combined amount to only 41.9 billion euros, the uncovered portion of the emergency credit granted to Greece amounts to 26.4 billion euros.
Seen in this light, the ECB is underwriting a delay in the filing for bankruptcy at the expense of the Eurozone taxpayers. It is ultimately the citizens of other Eurozone countries who, without having been consulted, are providing credit at their own risk to enable wealthy Greeks and foreign investors to whisk their money to safety.
For this reason, the emergency credit given to Greece should be capped at 42 billion euros, if the liability of the Greek central bank is to be taken seriously. The Greek government should then set up capital controls to keep Greek banks solvent – and to avoid more capital leaving the country. The Cypriot example should not be repeated.
Professor of Economics and Public Finance
President of the Ifo Institute
Published in similar form under the title “Impose Capital Controls in Greece or Repeat the Costly Mistake of Cyprus”, Financial Times, 17 February 2015, p. 9. Also published in German under the title “Die EZB betreibt Konkursverschleppung”, Süddeutsche Zeitung, No. 33, 10 February 2015, p. 18.