News Column

ELA violated many rules

August 2, 2014

By George Markides

IN MARCH 2013, the European Central Bank (ECB) issued an ultimatum to Cypriot authorities to accept a bailout package by March 25 otherwise they would cut off Emergency Liquidity Assistance (ELA). Cypriot banks, especially Laiki, relied heavily on ELA to continue operating.

By the end of March, Cypriot ELA peaked at €11.4 billion with Laiki, which was subsequently shut down, receiving close to €9.5 billion. Its ELA debt is now weighing down Bank of Cyprus (BoC).

But what is ELA?

We must understand that when we deposit money to a bank, it does not keep our money stashed away ready for withdrawal upon request.

If customers withdraw money en masse the bank could collapse. This is what happened to Britain's Northern Rock.

Under normal circumstances banks lend to each other in good faith (no collateral required) on the interbank money market charging interest.

If banks don't trust each other and therefore do not lend to each other, weaker banks may find themselves in a tight liquidity situation.

If a bank is unable to borrow from the interbank market, then it can borrow from the European Central Bank's (ECB) marginal lending facility by "presenting" high quality assets such as triple A bonds. The interest rate for this transaction is currently fixed at 0.4 per cent and is subject to change by the ECB.

If a bank is shut out from the interbank money market and does not have high quality assets for ECB lending, then the bank's domicile National Central Bank (NCB) may launch an ELA programme.

As per ECB guidelines: "ELA means the provision by a Eurosystem NCB of: central bank money to a solvent financial institution that is facing temporary liquidity problems… Responsibility for the provision of ELA lies with the NCB(s) concerned."

The amount of ELA given appears on the NCB's financial statements on the asset side of the balance sheet and is called "other claims on euro area institutions denominated in euro" the same terminology is applied throughout the eurozone. NCB's must publish their financial statements every month.

We have established that ELA is launched on the initiative of a NCB – not the ECB – and it is given to solvent institutions, meaning institutions with sufficient assets to be mortgaged with their domicile NCB in exchange for ELA.

The ECB also plays an active role. Specifically, the ECB must be informed by the NCB on: the amount of ELA that was disbursed, the recipient bank, the collateral/guarantees given, ELA's interest rate and an assessment of the bank's short and medium term solvency and liquidity positions.

This information must be submitted to the ECB either before or after the NCB launches an ELA programme. However, if the overall volume of ELA given reaches the €500 million threshold, the ECB must be informed prior to any extension of the programme.

If the NCB intends to provide more than €2 billion in ELA, the governing council of the ECB (the 18 national central bankers of the eurozone) must consider the risks from the continuation of the ELA operation and may reject an extension. ECB's bylaws state that a two thirds majority vote of the council is required to halt ELA operations.

By the end of March 2012 Cypriot banks had virtually zero ELA. However, by the end of April 2012 ELA exploded to €3.8 billion.

In July 2011, the European Banking Authority (EBA) published their EU-wide stress test results. They showed that Laiki needed to beef up its capital buffers by €1.8 billion.

Compounding Laiki's problems further was the haircut of Greek bonds, agreed by Greece's eurozone partners in October 2011 and implemented in spring 2012.

Therefore, Laiki needed capital and sustained huge losses to its Greek bond portfolio by more than 50 per cent. Moreover, Laiki's exposure to the recession-hit real estate sector and to Greece's retail market meant the bank was shaky at best.

ELA is provided to a solvent bank that is facing temporary liquidity problems. Laiki's solvency at this stage was questionable and its liquidity problems were not temporary, the implication being that the Central Bank of Cyprus (CBC) was violating ECB rules.

Even more alarming is the stance of the ECB. By the end of August 2012 the situation was clearly unsustainable (€9.5 billion ELA in just four months), however, the ECB allowed the CBC to continue providing ELA. The former CBC governor Panicos Demetriades said Laiki was kept on life support till after the (February 2013) elections.

We all know that Laiki's ELA was dumped on the Bank of Cyprus for repayment. This is yet another violation of ELA rules that clearly state: "Responsibility for the provision of ELA lies with the NCB(s) concerned. This means that any costs of and risks arising from, the provision of ELA are incurred by the relevant NCB."

The CBC had, in theory at least, sufficient assets mortgaged by Laiki that could be liquidated and recover part of the sum. In addition, since CBC bears the risk and cost arising from the provision of ELA it should have absorbed any loss incurred by overextending ELA to Laiki.




George Markides, BSc and MBA, is an economics researcher

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Source: Cyprus Mail

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