* ECB used funding stick on Cyprus, carrot on Ireland
* Without ELA cash that ECB controls, Greek banks would fail
* ECB Governing Council meets on Wednesday (Recasts)
By Paul Carrel and John O’Donnell
FRANKFURT, Feb 15 (Reuters) - The European Central Bank’s control over emergency funding for banks gives it the power to prod countries into the kind of aid-and-reform programme that Greece is desperate to escape.
The ECB is loath to pull the plug on Greece’s banks, a scenario that would almost certainly lead to the country’s exit from the euro zone. But if Athens refuses to extend the existing programme or sign up to a new one it may have little choice.
Time is short, and the ECB has Greece on a tight leash.
On Thursday, the ECB raised the Emergency Liquidity Assistance (ELA) available to Greek banks by about 5 billion euros ($5.7 billion) to 65 billion, extending the funding until Wednesday, when it will reassess the situation.
The ECB has already stopped accepting Greek bonds in return for funding, shifting the financing burden onto Greece’s central bank. However, the ECB retains control over that ELA funding, which is subject to tight conditions.
“If the Greek government says ‘we are not paying our debts’, then the banks are actually insolvent, because they hold a lot of Greek sovereign bonds,” said Volker Wieland, a member of the German government’s Council of Economic Experts.
The rules governing ELA stipulate that the euro zone’s national central banks can only grant such funding temporarily, and to solvent banks.
Denying Greek banks this funding “would be a way to bring Greece to an agreement quickly,” said Wieland.
This is a tactic the ECB has used before.
In March 2013, with Cyprus unwilling to accept the conditions for unlocking EU aid, the ECB set it a tight deadline to agree a bailout plan, threatening to cut off ELA funding to its banks. That quickly brought Cyprus to heel.
By contrast, Ireland used ELA to prop up its banks for months before the ECB agreed to a deal to ease its bank debts. But it also swallowed a severe dose of austerity medicine.
That made it a role model for the euro zone’s debt-ridden economies - something that Greece’s leftist government, with its anti-austerity demands, is clearly not.
The ECB’s Governing Council, which will reassess the Greek ELA on Wednesday, can restrict the funding operations if a two-thirds majority is in favour.
Some Council members’ patience is wearing thin.
Executive Board member Peter Praet said last week that ELA is “only for very short needs” and stressed the rules on provision to solvent banks should be applied. Bundesbank chief Jens Weidmann has called for “strict standards with ELA”.
U-TURN, OR GAME OVER?
Taking a strict approach would leave the ECB in an awkward position if Greece failed to agree a programme at Monday’s meeting of euro zone finance ministers but nonetheless remained in the euro zone.
“If Greece does not sign up to a programme but it’s still in the euro zone, it is basically in a state of limbo,” said Andrew Bosomworth, a senior portfolio manager at Pimco in Munich.
ECB Governing Council member Ewald Nowotny said on Thursday a lack of agreement on a programme would “definitely not” automatically see Greece’s banks cut off from ELA.
Yet the solvency of Greece’s banks is tied closely to that of the state, which needs the funding tied to its bailout programme. The existing programme runs out on Feb. 28.
The ECB wants euro zone governments to work out a deal for Greece’s future. A failure to do so quickly could accelerate deposit outflows from Greek banks, which have increased as EU negotiations have stalled.
“The Greeks have to do a complete U-turn soon,” said Berenberg bank economist Christian Schulz. “If not, I think there is a big chance the ECB will limit ELA. Then it will be ‘game over’ for the Greek banks.”
$1 = 0.8770 euros Additional reporting by Frank Siebelt; editing by John Stonestreet