Say yes to troika or risk a full-scale banking collapse

26 July, 2012 | Posted By: Fiona Mullen

 * Emergency Cyprus bank funding leaps to EUR 8 bln *

The reliance of Cypriot banks, or perhaps just one Cypriot bank, on emergency funding from the Central Bank of Cyprus has risen alarmingly in recent months, suggesting that the banking system is under increasing strain and will continue to be so until the troika funding comes through.
The figure called “other claims on euro area institutions denominated in euro”, which is the euphemism for Emergency Liquidity Assistance (ELA) from the Central Bank of Cyprus, shot up to EUR 8 bln in June 2012, from EUR 5.6 bln in May.
In June 2011 it was a mere EUR 171,708 (less than two hundred thousand).
One reason for the massive increase is the decision by the European Central Bank (ECB) to stop accepting Republic of Cyprus bonds as collateral for ECB liquidity assistance. The decision came just after Fitch Ratings became the third rating agency to put the Cyprus sovereign into junk status at the end of June this year.
But that cannot explain all of it. Inferring from the numbers, assistance from both the ECB and Central Bank of Cyprus ELA rose to EUR 13.2 bln in June from EUR 9.7 bln in January 2012 and EUR 5.8 bln in June 2011. Therefore, it is clear that the overall needs have risen.
Another likely reason for increased assistance is a certain local bank’s mismatch of group deposits and loans. According to the 2011 audited accounts, the mismatch was approaching EUR 5 bln at the end of 2011.
This gap might have widened even more in the period before the second Greek election, which would explain the sharp increase in ELA between May and June.
The decision to allow ELA lies with the board of the ECB. What is more difficult to establish is when the ECB decides it has to stop.
In theory, the ECB is not supposed to care, since liability for ELA is held by the central bank, or, in other words, with the country of the central bank.
But when that country cannot even borrow EUR 200 mln to roll over a few Treasury bills, then it is clearly an ECB problem.
If the ECB does not want assume a EUR 8 bln liability for Cyprus on top of the other loans it will be giving, it might just decide to call a halt to the ELA.
Even if the ECB does not call a halt to ELA, the numbers demonstrate that the longer the political leadership tries to argue with the troika, the bigger the strain on the banks and the higher the chances that something will simply snap.
I hope that the difficulties encountered by a couple of diplomats trying to get money out of any ATM this week are not a sign that this has already happened.
That is why the government needs to stop negotiating and simply sign on the dotted line. It will be far less costly than letting a bank collapse. That would bring down the entire banking system and take the economy back 30 years.
By Fiona Mullen
Director, Sapienta Economics Ltd