OREANDA-NEWS. April 27, 2015. The response of the European Central Bank would be key to the consequences of a missed payment by Greece to the IMF, Fitch Ratings says. We still see a last-minute deal to secure fiscal funding from Greece's creditors as the most likely outcome, but the risk of a missed payment cannot be discounted.

ECB executive board member Benoit Coeure said this week, in response to a question about the consequences of a possible missed IMF payment, that a government default and the impact on government bonds used as collateral "would make it more difficult for banks to obtain liquidity." He also said the ECB would "continue to extend liquidity to the Greek banks, as long as they are solvent and they have adequate collateral."

These and similar comments appear to imply that, although further restriction of Emergency Liquidity Assistance (ELA) would be more likely following a missed IMF payment, it is not certain. Press reports suggest that one consequence could be increased haircuts on the collateral.

ECB decision-making is a greater potential constraint than collateral availability. At end-February, Greek banks had around EUR50bn of remaining ELA collateral buffers, equivalent to around 35% of the system's domestic private-sector deposits. This can be pledged to access additional funding or to accommodate increased haircuts, implying that banks could cope with quite substantial deposit withdrawals, assuming the ECB continues to increase its ceiling on ELA as needed.

The ECB has considerable flexibility in how it interprets the rules under which it may continue, limit, or discontinue further access to ELA. Cypriot banks were not cut off from the ELA in 2013 despite concerns about bank solvency, although the ECB did make ELA extension conditional on Cyprus entering an EU/IMF programme. The ECB's response for Greece is likely to be tied to the progress of discussions between the Greek government and its European partners.

Further restricting ELA would be likely to damage depositor sentiment, potentially increasing withdrawals. This may ultimately lead to restrictions on the banking sector to reduce liquidity strains, including capital controls. Capital controls could be introduced in any case if deposit outflows were to accelerate. As Cyprus has shown, they would not necessarily entail a eurozone exit, and can eventually be reversed (Cyprus fully lifted capital controls on 6 April, two years after they were introduced). But capital controls present risks to relations with foreign creditors, and would be a negative signal, potentially further damaging consumer and investor confidence.

A missed payment to the IMF would be likely to increase pressure on Greek banks' 'CCC' ratings due to its potential impact on sentiment and therefore on funding and liquidity, through protracted and heightened deposit withdrawals and/or further ELA restrictions (imposition of capital controls affecting bank creditors would be likely to result in bank downgrades to 'RD').

The ECB is already preventing Greek banks from providing additional funding to the government, so any further tightening of ELA would primarily affect the banks' rather than the sovereign's liquidity position. The latter is being eroded by repayments to the IMF and the lack of external funding sources.

The timing of any fiscal disbursements from Greece's official creditors remains highly uncertain two months after they agreed to extend the country's existing EFSF programme to end-June. Greece repaid EUR450m to the IMF in April while running arrears to suppliers, and the government has told local authorities to transfer reserves held in commercial banks to the Bank of Greece, citing "extremely urgent and unforeseen needs." Greece faces further repayments to the IMF of around EUR750m on 12 May and EUR1.5bn in June.

The pressure on Greek government funding contributed to our downgrade of Greece's sovereign rating to 'CCC' from 'B' in March. A missed IMF repayment would not itself constitute a sovereign rating default (we assume the EFSF would not exercise its right to declare one of its loans to Greece due, triggering a cross-default clause in many privately held bonds) but could lead to a further sovereign downgrade. The increased risk of capital controls led us to lower our Country Ceiling for Greece to 'B-' from 'BB' in March.