ELA a eurozone printing press?

Emergency Liquidity Assistance, or ELA, is liquidity help offered by the national central bank of a eurozone country to solvent financial institutions that are "facing temporary liquidity problems, without such operations being part of the single monetary policy," according to the European Central Bank (ECB).

This mechanism is currently considered to be the lifeline for Greek banks as the ECB decided to stop accepting junk-rated Greek government bonds as collateral for lending to financial institutions in Greece as of February 11. Greece's banks have nothing else to offer as collateral apart from their own government bonds.

The move by the ECB was a reaction to the new government's announcement that it would end the austerity program mandated by the country's international lenders. Implementation of this program had been the explicit prerequisite for the ECB's continuing willingness to accept Greece's junk bonds.

As Athens said it would not seek an extension of the bailout program agreed by previous Greek governments that is set to expire at the end of this month, the ECB decided to cut off the money supply to Greece's banking sector.

No detour

And to make matters worse, the Greeks, fearing for their deposits, have been massively withdrawing money from the nation's banks. In January alone, the amount withdrawn amounted to about 11 billion euros. All these developments have once again raised the specter of a "Grexit" – a potential exit of Greece from the eurozone.

Despite the massive troubles, a rapid collapse of the Greek financial system is unlikely due to the leeway the ELA provides. The emergency loans offered by the Greek central bank would do the same job as loans offered by the ECB previously did before its decision to cut off liquidity to Greece.

In the current instance, Greek government bonds do not have to make a detour to Frankfurt, but are exchanged directly with the central bank in Athens for fresh money. The Bank of Greece, in this case, practically operates as a printing press.

According to the ECB Statutes, the national central banks in the euro area are responsible for the risk that such operations entail. But if Greece were to leave the euro, then these loans would remain stuck on other eurozone countries.

A non-transparent system

In a bid to preclude eurozone nations from starting their own money printing presses, the ECB makes the cost of such loans obtained through ELA much higher than that of other types of loans it gives out.

The interest rate paid by Greek banks on their ELA loans currently stands at 1.55 percent, according to an analysis by the Commerzbank. In contrast, solvent banks from other euro countries get money from the ECB for just 0.05 percent interest.

Analysts are not certain about these interest rates, however, as they claim ELA to be a non-transparent mechanism, as the national central banks are not obliged to reveal either the interest rate or the exact volume of their loans. It suffices if the banks disclose the ELA loans made by them under the category "other receivables."

This has had the affect of other countries not being squeamish about the ELA instrument. For instance, Ireland's central bank made ELA loans worth an estimated 50 billion euros to the country's banks in 2011 and 2012, which in fact exceeded the notion of short-term bridge financing.

Contradictions

The patience that the ECB had in Ireland's case was not repeated when it came to Cyprus, however. In the spring of 2013, ECB President Mario Draghi declared the end of the emergency loans Cyprus' central bank had been granting, thus pushing the country's politicians to come up with a solution.

Greece could face the same scenario, particularly as patience among the nation's international lenders slowly erodes, which is reflected in the discussions over further tightening of the ELA terms by the ECB Governing Council.

Nevertheless, it is equally plausible that Draghi raises the ceiling on the amount of ELA lending the Greek central bank is allowed to do, in his efforts to do "whatever it takes" to save the euro, as the ECB President promised in the summer of 2012.

It may seem like a contradiction that the ECB still accepts certain bonds, despite not considering them to be safe, using indirect ways in an attempt to safeguard the euro system. But such contradictions have been anything but rare since the outbreak of the debt crisis in the eurozone.

For instance, the ELA lending should only be granted to solvent banks. But as the new Greek Finance Minister, Yanis Varoufakis, openly admits he is a bankrupt country's finance minister, then his country's banks are even more so.