ECB’s Emergency Cash Becomes Last Bulwark Against Chaos

The euro area has just come as close as it ever has to learning that what the European Central Bank gives, it can also take away. Before euro-area ministers agreed a last-ditch bailout in the small hours of Monday morning, Cyprus was hours away from being cut off from central bank funds and cast into financial chaos.

The threat that the ECB’s governing council would order a stop to so-called Emergency Liquidity Assistance for Cyprus as of close-of-business today is arguably what focused minds and helped forge a deal that will see the country’s second-largest bank shuttered.

For the uninitiated, ELA is an ad-hoc credit line extended by national central banks that exists in parallel to the ECB’s own satisfy-all-requests loan policy that has been in place since the beginning of the financial crisis. It means banks can get cash against poorer collateral than normal Frankfurt rules would allow, for a higher rate of interest.

It’s supposed to be limited to “the temporary provision of liquidity in very exceptional circumstances,” according to a pre-crisis description of its function in 2007. Recipients still have to be “solvent,” though, which is why Cyprus was threatened with shut-off. Without the prospect of recapitalization or restructuring for the banking sector that an IMF-EU adjustment program would bring, bankruptcy beckoned.

After deployment in countries including Ireland, Greece, Belgium and Cyprus throughout those nations’ banking-sector difficulties, ELA is no longer so very exceptional. The ECB’s threat to withdraw it from Cyprus, and the response that produced, has taught us that ELA has become the euro area’s indispensable weapon against banking-sector collapse.

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