The Bank of Greece, the ECB, and the Euro

One of the little remarked on issues if Greece either decides or is forced to leave the Eurozone is how the Bank of Greece and the European Central Bank (“ECB”) would accomplish the divorce. It is difficult to get a handle on this for two reasons. First, there is no provision for a country to leave the euro in any of the legal documents that created the common currency, since the adoption of the euro by an EU member state was deemed to be irreversible. Second, the information provided by the ECB on its website is sparse concerning technical details. (The websites of the Federal Reserve System provide more information and provide it more clearly.) Because of this, what I have written here is my understanding of the situation, but there may be errors given the opaqueness of the publicly available information about Eurozone monetary policy and the operations of the ECB and the national central banks.

Much of what is done with respect to monetary policy, except for all-important decisions, is handled by the national central banks, not the ECB. The ECB, unlike the Board of Governors of the Federal Reserve System, is an actual bank, with assets and liabilities. However, much of the assets and liabilities of the Eurosystem are carried on the books of the national central banks.

The May 2015 balance sheet of the Bank of Greece shows on the liability side €27.4 billion of euro banknotes and €17.8 billion of euro banknotes allocated to it in the Eurosystem. It also shows €100.3 billion of liabilities related to the Target2 cross-border payment system of the European System of Central Banks. On the asset side, the balance sheet shows €38.8 billion of lending denominated in euros and related to monetary policy to euro area credit institutions (presumably mainly Greek banks) and €77.6 billion of other claims denominated in euro to euro area credit institutions. How these liabilities and assets (and others) would be handled or taken off the Bank of Greece’s balance sheet and transferred to the ECB and other national central banks is unclear.

It seems likely that the current Greek government had not thought about this during the painful negotiations with the other Eurozone countries. The majority of Greeks want to stay in the euro, though they hate the austerity that has been imposed. Since the Greek government could not credibly threaten to leave the euro and tell the Eurozone countries that they would lose additional amounts in addition to the debt they hold due to the monetary divorce, this gave the hard-line countries a negotiating advantage. The Germans and other essentially told Greece, leave the euro, we don’t care. At the same time, of course, the ECB was strangling the Greek economy by not allowing the Bank of Greece to provide additional credit to Greek banks. The Eurozone countries play rough.

Given all the current problems with the deal that was arrived at earlier this week, there should be some study of how to extricate the Bank of Greece from the euro. Greece’s departure from the euro is certainly a possibility at some point, and the taboo of considering it has been broken.

After all, the current deal may fall apart. The IMF may not extend more credit to Greece unless it is given relief on its current debt, which the Germans say they do not want to do. There seems little likelihood that the Greeks will be able to privatize enough assets in short order to put €50 billion in an escrow fund. Moreover, the economic policies imposed on Greece, assuming the Greeks carry them out, will likely hurt economic growth, making its debt problem even worse.