How capital controls work
June 29, 2015
It was 1 a.m. on Saturday morning, when Greek Prime Minister Alexis Tsipras told his countrymen that he would ask them to vote on Greece's economic future in a referendum. Very shortly afterward, queues began to form in front of cash machines - in the middle of the night. The queues got longer as night turned into day.
Many Greeks now prefer to keep their money at home, in cash, rather than in a bank. They know that if Greece leaves the eurozone, the country would receive a new currency, and euro bank deposits would be compulsorily exchanged for "new drachmas" at an official exchange rate that would likely be very unfavorable to savers. Those who held euros in cash, or in foreign bank accounts, would be able to trade them at much more favorable rates on private or unofficial foreign exchange markets, later on.
Help from the European Central Bank
The continuous outflow of deposits from Greek banks has been a heavy burden on their balance sheets in recent months and years. In order to remain "liquid" - bankers's jargon meaning: able to honor savers' requests to withdraw funds - Greek banks have had to turn to the European Central Bank for emergency assistance, within the framework of the ECB's so-called "Emergency Liquidity Assistance" (ELA) program.
ELA has granted troubled banks "liquidity assistance" - in essence, cash loans - against certain kinds of collateral, such as covered bonds or government bonds. ELA loans are meant to run for a limited period and provide limited sums. However, over the course of Greece's economic and banking crisis, the ECB's Governing Council has repeatedly raised the ceiling on total ELA loans available to Greek banks. The ceiling now stands at around 90 billion euros.
Now that Greece's economic and political crisis has entered a new phase, the ECB has announced that the Greek banking system's ELA ceiling will not be raised further. In order to ensure that Greek banks remain "liquid" nevertheless, the government of Greece has imposed "capital controls" - in effect, limits on the amount of money people are able to withdraw from their accounts or transfer to banks outside Greece.
Restrictions on financial freedoms
The free flow of money is one of the four fundamental freedoms of the European Union. It can be restricted only in an emergency - "in case of serious difficulties in economic and monetary policy", according to the law governing the EU's common internal market. Even then, any restrictions may be applied only for a limited time. This is meant to ensure that the financial freedom of citizens is curtailed for the shortest possible time - and to enable businesses to regain access to needed capital as quickly as possible.
Experience in Cyprus
In practice, things look a bit different. Cyprus gained recent experience with capital controls in the wake of its banking crisis, which broke out in 2013 and pushed the island country's financial institutions to the verge of insolvency.
The government imposed a limit of 300 euros per person per day on ATM withdrawals. Cypriots travelling abroad were not allowed to take more than 1,000 euros per person out of the country. Families who were financially supporting children studying outside the country were limited to transfers of 5,000 euros per quarter. Payments with debit and credit cards were also limited to 5,000 euros. Transfers of more than 5,000 euros to foreign bank accounts needed a special permit. Companies had to document every single transfer.
The controls stayed in place for quite a long time, and were only gradually withdrawn over a two-year period. The last of them were lifted in April this year.
In addition to direct capital controls like these, there are also indirect ways of controlling the movement of capital. For example, transfers to foreign bank accounts can be charged a special transfer tax, which tends to discourage such transfers.
The capital controls imposed in Greece are likely to be informed by the recent experience of Cyprus. However, the situations of the two countries are different. Cyprus has substantially recovered from the economic depths it plumbed in the aftermath of the 2008 global financial crisis. Greece hasn't.
In Greece's case, the question of whether the country will - or should - remain a member of the eurozone is likely to persist much longer. As long as the country remains dependent on emergency loans or transfers, the durability of its membership of the common currency will remain an open question. Greece is sailing stormy economic seas - and as soon as one storm blows over, the next one, it seems, comes raging in.