Impose capital controls in Greece or repeat the costly mistake of Cyprus

Hans-Werner Sinn
Financial Times, 17.02.2015, p. 9

Another crisis, another insidious bout of capital flight. In today, as in Cyprus three years ago, depositors are withdrawing bundles of euro notes to be spirited out of the country. Most of all, investors are rushing to make electronic transfers to banks elsewhere in the eurozone. In December 2014 alone, €7.6bn were sent abroad, equivalent to about 4 per cent of Greece’s economic output.

In 2012, Cyprus was in a similar bind. Wealthy Cypriots (and foreigners who had deposits there) tried to whisk their funds to safer places, draining liquidity from the island’s banks and threatening them with insolvency.

The Cypriot central bank kept the system afloat by lending out €11bn of newly created money under a protocol known as Emergency Liquidity Assistance. These funds were in effect borrowed from other eurozone central banks, which put euros into the new accounts outside Cyprus that were being set up by fleeing investors.

Without that support, Cypriot banks would have gone under, and depositors could have withdrawn no more cash. As it was, capital flight — financed by other eurozone central banks — continued until spring 2013, when the abuse of the eurozone’s emergency protocols grew too large to ignore and the pulled the plug. Cyprus then had no choice but to impose capital controls; without the ECB’s generosity, it would have done so much earlier. By the time Laiki Bank was pushed into insolvency, it had received €9.5bn in ELA credits.

The situation is not yet as extreme in , but it is heading that way. The exodus of capital must have increased significantly as the new year started, as Greece’s incoming government met a cool response in European capitals to its demands for more money.

We do not yet know the so-called Target balance owed by the Greek central bank to the rest of the eurosystem at the end of January. But we do know that the Bundesbank’s Target claims on the ECB jumped by €55bn, the third-largest increase since the outbreak of the financial crisis eight years ago. This signals a huge flow of money into Germany. A portion of it is likely to come from Greece.

The resemblance is worrying. To repay what it owed eurozone monetary institutions, Cyprus later received €10bn from a rescue programme put together by the governments of eurozone countries. Once the ECB council had put taxpayers on the hook, parliaments had no other option but to haul them out. We cannot allow this situation to be repeated in Greece.

Last week the ECB Council curtailed the Greek central bank’s ability to lend newly created money to commercial banks. Previously, this was allowed so long as debt issued or guaranteed by the Greek government was handed over in return, but assets backed by the Greek state are no longer deemed acceptable collateral. Access to the national printing press had apparently been used up already, to finance the efforts of wealthy Greeks, banks and international investors to flee a sinking financial system.

But, to compensate for this restriction, the ECB Council allowed the Greek central bank to grant up to €65bn in ELA credit to its commercial banks, under the same emergency mechanism as in Cyprus three years ago.

While the ECB argues that the Greek central bank itself is liable for repayment, this sum is far larger than the resources that the Greek central bank could draw on to repay its obligations to the rest of the eurosystem should banks be unable to repay the ELA credit.

The Greek central bank could be said to “own” about €38bn of the eurosystem’s stock of central bank money, in the sense that it is entitled to the permanent flow of interest income it generates. In addition, the central bank is entitled to the returns on €4bn of equity, including valuation reserves. That leaves a shortfall of €23bn. This repeats the mistake made in Cyprus, where ELA credits exceeded by 244 per cent the amount that the central bank was in a position to repay.

The ECB is underwriting a temporary reprieve for Greek banks that would otherwise be bankrupt, and doing so at the risk of 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 to whisk their money to safety.

The Greek central bank should not be allowed to live beyond its means. Assistance for the country’s commercial banks should be capped at €42bn. The Greek government should then set up capital controls to stop money from leaving the country and keep its banks solvent. The Cypriot example should not be repeated.