The major sources of funding for European banks are usually deposits, the interbank and private debt markets and the liquidity operations carried out by the European Central Bank (ECB). During the crisis, the markets remained closed to many banks, whose dependency on the Eurosystem increased considerably. Specifically, the ECB provides two channels of funding: regular liquidity operations (MROs and LTROs) and emergency liquidity  assistance (ELA). The latter is considered to be a source of financing of last resort, only employed when banks have particular liquidity problems, and it is therefore infrequently used. However, Greece's banks have had to resort to ELA to offset the deposits lost as a result of its recent political instability.

In general terms, banks use ELA when they do not have enough eligible assets as collateral to obtain financing
in ordinary operations. Since they do not meet these criteria, they choose the ELA provided by national central banks (which assume the credit risk) but at a higher cost, as the collateral conditions are more flexible. However, although these financial operations are managed by national banks, the ECB maintains control by setting the maximum funds permitted (68.3 billion euros in the Greek case) and the possibility to cancel them if it believes they interfere with its monetary policy mandate.

Over the last few months Greece's political instability has led to bank deposits plummeting, falling by 9.7% between November and January. This contraction in liabilities has increased the liquidity required by Greece's banks which, lacking eligible assets and as a last resort, have had to turn to ELA. Two decisions by the monetary authority have accentuated this lack of collateral. The first and most recent was the suspension of the eligibility of Greek government securities as collateral in the ECB's liquidity operations.1 The second was the exclusion of government-guaranteed bank bonds as collateral as from March. The first reduces eligible collateral in the Eurosystem by 8 billion euros while the second affects almost 50 billion. Although these guaranteed bonds were already due to become ineligible, and many of them mature very soon, the banks have continued to depend on them to finance 50% of the funds obtained from the Eurosystem.

The fact that a considerable proportion of the collateral in the Greek banking system can only be accepted via ELA, and that the limit to these emergency funds totals 68.3 billion euros (almost 60 billion have already been used), could make it difficult to finance the banking system if deposits continue to be withdrawn. As an example of just how necessary it is to reduce political instability by the government reaching an agreement with European institutions, we have simulated the financing capacity of Greece's banks in the Eurosystem2 in different scenarios. If deposits continue to be withdrawn at the same rate as in January (7.3%), by April the banks will find it difficult to finance themselves as they will not have enough eligible collateral. But if deposits shrink at the average rate achieved between November and January (3.3%), this will not be a problem until June.

Although deposits are not expected to continue falling at this rate, such figures underline the risk that would exist should political instability and the consequent deposit outflow not be curbed.

1. Participation in the bail-out programme made this debt eligible, albeit with a low credit rating. If the programme is extended, it might be accepted again.

2. Both via the ECB and ELA.