By Robert Peston, BBC
The biggest threat to an orderly resolution of Greece’s new debt crisis is that the European Central Bank ceases to fund Greece’s banks.
And the ECB may well feel obliged to turn off the tap, since right now it is only financing those banks because the country is officially complying with the terms of its IMF and eurozone bailout.
So at the moment that Greece was deemed not to be in compliance, it is difficult to see how the ECB could continue to provide emergency liquidity assistance to Greek banks.
They would then be in dire straits.
Without the ability to replace lost deposits with cash from the ECB, obtained via so called repurchase agreements or repos, Greek banks would run out of cash – because the uncertainty over Greece’s financial future is causing depositors to withdraw billions of euros every week.
Here is where it gets a bit technical, surreal and scary (if you’re not scared already).
When Greek banks borrow from the ECB, they hand over part of their holding of Greek government debt as security or collateral. Without this collateral they could not get the money.
But this debt has a junk credit rating, so under ECB rules it should not qualify as collateral for emergency loans.
The thing is that Greece and its banks have a waiver from the prohibition on using junk as collateral, because Greece is deemed to be in compliance with the terms of its 172bn euro eurozone/IMF bailout.
So if there were ever a formal decision that Greece is in breach of bailout conditions, at that point Greek banks would no longer have access to money from the ECB. And at that point, pretty much everything would fall apart in a financial sense for Greece.
Those still with euros in Greek banks would presumably demand their money back – and if there were such a run, the banks would face collapse.
And the moment that Greek banks were unable to swap Greek government debt for euros from the ECB, the Greek government itself would lose its last source of credit.
In those circumstances, it is hard to see how the Greek government could avoid default on its debts not only to lenders but to those from whom it buys services.
At that juncture, the Greek government would have little option but to abandon the euro for a new currency, nationalise its banks, and impose sweeping controls on the export of capital.
It would be out of the eurozone – at who knows what cost both to it, and to the rest of Europe.
Or to put it another way, the ECB has the power of life and death over Greece.
And given that the ECB is one of the troika that monitors whether Greece is in compliance with the bailout, this is a responsibility that it can’t delegate to other technocrats.
Presumably the Greek government and the troika have the ability to fudge for a period whether decisions by Mr Tsipras and his team to abandon the privatisation programme represent a formal bailout breach.
But on February 28, Greece’s bailout formally ends, unless a rollover is agreed. That is judgement day for Greece, with the ECB as hanging judge or rehabilitation judge.
As a supposedly apolitical central bank, the ECB and its president Mario Draghi will not be relishing their power to determine whether Greece stays or leaves the euro.
