ECB President Mario Draghi, left, and Greek Prime Minister Alexis Tsipras

ECB won’t pull plug on Greek banks just yet

In the end, the European Central Bank decided to maintain its lifeline to Greece’s foundering banking sector Wednesday, apparently reluctant to take drastic action ahead of the country’s July 5 bailout referendum despite the sector’s doubtful solvency.

News reports said the ECB’s Governing Council opted to leave the amount of Emergency Liquidity Assistance, or ELA, available to Greek banks frozen at around 89 billion euros ($98.4 billion). They also made no decision on whether to demand tougher haircuts on Greek bonds and other government-backed debt used as collateral for that funding, a move that would have effectively tightened the amount of liquidity available.

A decision to tighten the screws on Greece’s banking sector would have come as a surprise. But the situation nonetheless offered a dilemma for the Frankfurt-based ECB.

Under the ECB’s rules, ELA can only be provided to banks that are seen as solvent. Greek banks can hardly be considered solvent right now.

“It is very difficult to see how one could conclude that banks that are basically closed because they have no access to cash, operating under a government that has just defaulted to the IMF, could possibly be solvent,” said Gary Jenkins, chief credit strategist at London-based LNG Capital, in a note.

Greek banks were left to rely on emergency funding after Europe’s central bank earlier this year revoked a waiver that had allowed the institutions to pledge junk-rated Greek government bonds as collateral in exchange for short-term loans via the ECB’s regular-funding operations.

Accelerating deposit withdrawals coupled with the ECB’s decision last week to freeze ELA last week, after Greek Prime Minister Alexis Tsipras shocked creditors by calling a bailout referendum, little choice but to close banks and impose capital controls ahead of the Sunday referendum on creditor demands.

That meant the ECB faced a political decision “as to whether the ECB sticks to its rules or decides to keep everything as it is (which in itself is a tightening of conditions) so as not to be accused of interfering in the referendum,” Jenkins wrote Wednesday morning.

Such logic appeared to win the day.