Greek exit depends on bank funding, not govt: Expert

This week the spotlight is solely on Greece. Banks and analysts are now openly counting the losses to the euro system in case of a Greek exit.

The investment division of Barclays Bank calculates that if Greece were to exit the euro system, losses to the euro area would be 100 billion euros or 1% of Europe's GDP. The calculation is based on bilateral loans to Greece, exposures through the EFSF and exposure to Greek bonds. The point about this calculation is not its veracity but that now a Greek exit is being seen as a high probability. However, with a run on one Spanish bank and incessant fall in all asset classes, people are beginning to wonder whether a Greek exit would mean challenging the euro system itself. In an interview with CNBC-TV18, Charles Goodhart, Professor of Economics at LSE, a former member of the UK monetary policy and one of the best commentators on central banking gives his view on the Greece-EU tussle. Professor Goodhart points out, "It is possible for Greece to stay in the euro so long as the banks can keep running. That is the crucial issue. It's the banks that you have to watch not the government." Below is the edited transcript of the interview on CNBC-TV18. Also watch the accompanying videos. Q: Do you believe that Greece exiting the euro is more or less inevitable now? A: No. What I think is inevitable is that the TROIKA will not provide additional funds to the Greek government. The Greek government will default on its bonds. But, that doesn't necessarily mean that they would have to leave the euro. Q: I am confused. How can Greece default and yet stay in the Euro. It won't get more bailouts. How do you reconcile these two positions? A: The key issue is whether the ECB and maybe the IMF will be prepared to recapitalize the Greece banking system. If the Greek system can carry on and be recapitalized then Greece can, if it is prepared to do so, remain within the Euro. What would happen would be, without funding from the TROIKA, they would have to immediately cut all their expenditures to what their tax revenues would allow them to payout. But, that is durable and it is even arguable. It would be a salutary experience for Greece to have to face a really hard budget. Q: According to you, is this the most likely scenario that the TROIKA will come and protect the banks and not help the sovereign? What according to you is the most likely scenario? A: The key thing is to keep your eye on the banks and also the degree to which there is a panic run on the banks. If the banks can be kept in business then don't worry so much about government financing. It will actually be good for Greece to have to cut back their expenditures to what they can properly afford. The Europeans are not going to put more money down there, given that the Greeks are not going to accept the conditional austerity further. But, it is possible for Greece to stay in the euro so long as the banks can keep running. That is the crucial issue. It's the banks that you have to watch not the government. _PAGEBREAK_ Q: Europe doesn't seem to be heading that way. The ECB has actually not been lending to some Greek banks on the ground that they are not sufficiently capitalized. Who do they expect will capitalize these banks? A: That is a really rather confused and difficult story. A certain amount of the funds, which had been promised under the bailout agreement to recapitalize the Greek banks have apparently been transferred to Greece. But it has not been paid out to the banks yet, because of discussions between the Greek government and the Greek banks. There maybe a further trunch of funding, which may possibly come to the Greek banks. This is a very confused situation. But the critical issue is how will the banks manage to survive and in what way and by whom will they be recapitalized. Q: But we don't see such a scenario crystallizing at least as of now, do you see it happening after the Greek elections? A: No, I think that's where it's really going to develop. I think there is no chance of the Greek politicians after the election agreeing to further austerity measures. I think that there is no chance of the TROIKA putting down more funding to the Greek government. But I don't think more funding for the Greek Government is necessarily crucial. The Greeks will thus, have to cut their cloth, meat - whatever revenues they can put together. It's not the government finances that are absolutely crucial now, it is the bank finances. Q: Let's look at the alternate scenario if Greece does exit. How will events pan out? What happens to European banks? What happens to their sovereign debt? A: If you assume that Greece is forced to leave the Euro and turn back to the Drachma, the Drachma would fall very sharply. And everyone who had deposit with the Greek banks would lose a lot of money. That would be a story that would frighten a lot of people in other countries. But it's very difficult to say how people would react because that ought to leave the authorities, including all the European authorities and the IMF, to put into action immediately some countervailing measures to ensure that there is a firewall to prevent contagion going over to the other countries. The questions that really matters are what pre-planning have they done and what have they in readiness to put into action immediately, should Greece actually exit the Euro. And we don’t know that. Q: How will an exit impact Greece itself? Won't it be much more traumatic crises for Greece? A: It would be very messy for Greece. It would also be fairly messy for Cyprus because Cyprus is so closely and totally interacted and involved with Greece. So the idea that it is one is not necessarily true. It would be two - Greece and Cyprus. Whether it is messy, how it happens and what the sequence would be, I think is something that is almost impossible to tell now. _PAGEBREAK_ Q: In the next few days, do you see the ECB stepping in to ameliorate the situation? Do you see them buying bonds? A: They have already done two LTROs and the banking systems in the periphery are not in trouble because of lack of liquidity. What is a worry is not liquidity, it's whether they are sovereign, whether they have a positive asset balance and LTROs don't really deal with that. You could say that propping up the value of the sovereign bonds would help the banks and indeed it would. But, there is a concern whether this is an appropriate policy for a central bank to undertake and whether this should not be done if it is to be done by the political authorities rather than the central bank. Q: The expectation of the ECB buying bonds comes from the fact that last time around when Spanish and Italian bonds went above 6%, the ECB did these long-term refinancing operations? A: The problem then was a funding crisis of the banks. The banks had a lot of longer term debt rolling off. No one was actually lending to the banks. It actually was a liquidity problem and they did deal with that liquidity problem. I don’t think the current problem is one of liquidity. It's not one of having enough funds. It's a problem really of whether they are afloat or whether they are sovereign. Q: This Greek bank capitalization, when do you see the debate going in that direction at all? A: It's actually becoming quite important that it should occur before the Greek elections because the extent of withdrawal of deposits from the Greek banks has been so strong in the early days of weeks that one needs to have some measures to ensure that the Greek banks are viable. You can't just wait till 17th June, given the amount of disturbance and uncertainty in markets. This really does need earlier resolution. Also read: Recapitalize Greek banks to prevent fear in mkts: Expert