HOW TO STOP GREECE´S "BANK JOG" / THE FINANCIAL TIMES COMMENT & ANALYSIS ( A MUST READ )

How to stop Greece’s “bank jog”
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Mohamed El-Erian
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May 28, 2012

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Bank runs are not supposed to happen in a modern advanced economy. Yet, newspapers reported last week that Greek depositors were stepping up their withdrawal of savings held in local banks. Understanding why this is happening – and what we can do about it – is key to assessing the threat to European and global growth, jobs and financial stability.

There are two critical safeguards against the start and disorderly acceleration of bank runs: national deposit insurances schemes and central bank provision of emergency liquidity. They kick in once the banking system’s first line of defence – which consists of strong capital and good assets on the balance sheet – is breached.

Many banks were caught offside by the global financial crisis and the widespread economic and financial deterioration that followed. The result was a sharp erosion – both real and perceived – in capital cushions relative to the quality and size of the assets. Moreover, given the heavy concentration of government bonds on banks’ balance sheets, the situation took a further and significant turn for the worse with the downgrading of sovereign creditworthiness in some European countries, and most prominently in Greece.





Worsening sovereign risk also served to undermine the credibility of the circuit breakers designed to minimise the probability of bank runs. After all, national deposit insurance schemes are as credible as the sovereigns that stand behind them. And with access to emergency central bank liquidity involving the pledging of assets that themselves are now under severe pressures, such funding becomes less straightforward.






These dynamics are dramatically playing out in Greece due to self-reinforcing concerns about another debt default, the imposition of capital controls, and currency denomination that would accompany a possible eurozone exit. In addition to pushing the country further to the edge, they raise legitimate worries about the risk of yet another wave of negative contagion for some other European countries – particularly through the further destabilisation of bank deposits.






Greece’s “bank jog” needs to be immediately stopped if it is not to evolve into a full-fledged bank run with region-wide implications. And to do so, Greece requires even greater support from its already (and understandably) reluctant eurozone partners.






An incredibly disruptive situation could be avoided if Greek depositors were given quick access to a region-wide (as opposed to just national) deposit insurance scheme that is unambiguously supported by the fiscal authorities in the strongest eurozone countries. This would need to be coupled with even larger liquidity support from the European Central Bank, along with direct capital injection into the Greek banks from regional funds (e.g., the European Stability Mechanism, or ESM) and multilateral institutions (namely the International Monetary Fund).


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Finally, agreement would be needed on how and when to impose burden sharing on banks’ equity holders and bond creditors.



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Add these financial requirements to the considerable sums already committed to Greece to cover its primary budget deficit, meet interest payments, roll over maturing debt, and facilitate much needed structural reforms. Each serves to complicate an already tense and stretched relationship between Greece and the troika (ECB, EU and IMF). Together they pose a considerable and urgent challenge – and one that makes it even more difficult to reconcile simultaneously cascading financial demands, economic imperatives, conditionality design, and democratic realities.





Whichever way you look at this troubling situation, last week’s intensification of deposit flight in Greece is much more than just a new wrinkle in what has become a protracted European crisis. If the phenomenon spreads, and it will in the absence of a credible region-wide policy response, control of Greece’s destiny within the eurozone would slip even further away from politicians and policymakers and more directly into the hands of a population that is approaching the June 17 election in a mood of rejection. Already this rejection is not that far from tipping Greece into a classic funding panic and the eurozone into even greater turmoil.