Bonds Drop

Greek shares and bonds fell on Monday, with the benchmark Athens Stock Exchange dropping 1.4 percent at 1.28 p.m. local time. The ASE has fallen 26.3 percent in the past year, making it one of the worst-performing primary equity indices tracked by Bloomberg. Yields on two-year Greek notes jumped 280 basis points to 23.71 percent, the highest level this month. Greek bonds remain the best-performing sovereign securities over the past month, according to Bloomberg's World Bond Indexes.

While talks are centering on whether to give Greece more money, the ECB could decide to raise the stakes as soon as this week if it increases the discount on the collateral Greek banks pledge in exchange for cash under its Emergency Liquidity Assistance (ELA) program.

Such a move might inadvertently prompt a further outflow of bank deposits and pressure Tsipras to choose between doing a deal and putting his country on the road to capital controls. A Greek government spokesman declined to comment, as did officials at the Greek central bank and the ECB.

“We are in an endgame,” ECB Executive Board member Yves Mersch said in an interview with Luxembourg radio 100.7 broadcast Saturday. “This situation is not tenable.”

The arithmetic goes as follows: Greek lenders have so far needed about 80 billion euros ($91 billion) under the ELA program.

Banks have enough collateral to stretch that lifeline to about 95 billion euros under the terms currently allowed by the ECB, a person familiar with the matter said. With the central bank raising the ELA by about 2 billion euros every week, that could take banks to the end of June.

A crunch will come if the ECB increases the haircut on Greek collateral to levels not seen since last year. That could be prompted by anything from a complete breakdown in talks to a missed debt payment, the official said. A continuation of the current impasse could even be all that's needed, the official said.

An increased haircut would reduce the ELA limit to about 88 billion euros, the person said. While that gives banks about four weeks before hitting the buffers, the leeway is so limited that Greece might need to impose capital controls, limiting transactions such as ATM withdrawals, to conserve the cushion. Market News International first reported on the reduced ceiling on May 12.

“Since the great crisis of 2008, Europe has created many tools to control the flow of money and banks,” said Andreas Koutras, an analyst at In Touch Capital Markets in London. “Thus the crisis in Greece is more likely to be resolved through the tools of the ECB rather than” by political means.

Investors in Greek debt are showing few signs of panic for now, with the yield on the Greek 10-year bond having dropped about 3 percentage points from the 13.64 percent on April 21.

Nor are ECB policy makers willing to raise the pressure on Greek banks on their own. Central bank governors won't take any action which would be seen as pushing Greece out of the currency bloc if negotiations show progress and convergence, the person said.

Collateral Fix?

Greek lenders are also working with the country's central bank on plans to collateralize additional assets, a separate local official with knowledge of the matter said.

Still, it's unclear if these assets, including government guarantees, would be accepted by the ECB if the standoff in bailout negotiations persists. According to a senior Greek commercial banker, the ECB's decision on what to accept as collateral is essentially a judgment call, and not necessarily related to the quantity of the assets available.

“The Greek government at this point has no room for maneuver,” Spanish Economy Minister Luis de Guindos said in a speech in Madrid on Monday. He said he was still optimistic a deal will be reached in the coming days. “This deal is essential for Greece given its liquidity situation,” he said.

Tsipras will push Greece's case at this week's EU leaders' summit in Riga after a weekend that showed few signs of progress. An International Monetary Fund memo dated May 14 said Greece won't be able to make an IMF payment on June 5 unless an accord is reached with partners, the U.K's Channel 4 news reported on Saturday.

The ECB's next full monetary policy meeting is on June 3, two days before the IMF payment.

“There were too many people crying wolf before,” Koutras said. “But as Hemingway wrote: How did you go bankrupt? Two ways: Gradually, then suddenly.”

–With assistance from Maria Tadeo in Madrid.

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