* Emergency ELA facility could offer Greece back-door funds
* Irish central bank already uses ELA to fund its banks
* Rating agency downgrade may only be temporary
* ECB could look to troika on collateral, shun agencies
By Paul Carrel
FRANKFURT, July 5 Downgrade or no downgrade, the European Central Bank has ways of keeping liquidity flowing to Greek banks while also ensuring its lending requirements are covered -- with a fig leaf, at least.
Ratings agency Standard & Poor's warning on Monday that it would treat a French bank plan for a rollover of privately held Greek debt as a default cast new uncertainty over euro zone efforts to rescue Greece.
The ECB has said it would stop accepting Greek bonds as collateral were the country to default on its obligations.
This approach is aimed at making sure euro zone governments -- with or without the private sector -- assume the cost of dealing with the crisis, rather than pushing it over to the ECB, which fears its independence being compromised.
In the high-stakes standoff over the Greek crisis, the collateral card is the closest the ECB has to an ace: refusing to accept Greek sovereign bonds as collateral would deprive Greek banks of the funds on which they rely, crippling the Greek economy and risking contagion to other euro zone economies.
By threatening to use this 'nuclear option', the ECB hopes to press the governments into avoiding a temporary default, and the contagion it fears would follow. It could compound Greece's woes if it refused to accept state-backed assets as collateral in the event of the sovereign being downgraded.
But what if the governments call the ECB's bluff -- or are unable to agree on a plan acceptable to all sides -- and decide to go ahead with a bailout package that triggers a rating downgrade to a default category?
"Given that so much progress has been made towards saving Greece, I would not expect that the ECB would kill the whole process ... but I think they will (play) poker until the very last moment," said Berenberg Bank economist Christian Schulz.
"They don't want to let governments off the hook," he said. "Everybody is playing poker and nobody wants to put their cards on the table."
The imminent threat of Greece defaulting was lifted last week when the Greek parliament approved detailed austerity and privatisation bills in a crucial vote to secure emergency funds and avert bankruptcy, but it is in no way out of the woods.
If as a result of a second bailout which is expected to total around 120 billion euros and which Germany and others insist must include private creditors, Greek sovereign bonds cease to satisfy ECB collateral standards, euro zone central bank officials point out the national central bank can step in.
National central banks can provide commercial lenders with liquidity via the Emergency Liquidity Assistance (ELA) facility and this option would have to be considered if Greek sovereign bonds were no longer adequate for the ECB, the officials say.
Ireland's central bank is already giving its domestic banks back-door access to funds via ELA -- financing provided with the ECB's blessing in exceptional circumstances on a case-by-case basis to 'temporarily illiquid but solvent institutions'.
"In our view it would be possible to use ELA to provide financing to Greek banks in the event of a selective default," Barclays Capital economists said in a research note.
Under one scenario, Greek banks could tap the ELA for a short period while the ECB temporarily deems the sovereign bonds inadequate for collateral in its funding operations.
That possibility was given credence by S&P which said that once one of the options envisaged under the French rollover plan was implemented, "we would assign a new issuer credit rating to Greece after a short time reflecting our forward-looking view of Greece's sovereign credit risk."
It stopped short of saying unequivocally the new rating would take Greece out of the default category -- but such a possibility means its bonds may only be inadequate for ECB collateral operations for a short period.
Another glimmer of hope was offered by ratings agency Fitch which said last month that under a voluntary scheme, it may temporarily downgrade Greece's 'Issuer Default Rating' to 'restricted default' but keep the government bonds at 'CCC'.
"Can they come up with a circumvention solution where the Greek issuer is in default but the bonds are not, so we can continue to take the collateral?" asked Nick Matthews at RBS. "That blurs things a little bit around the edges."
Matthews said the S&P warning showed it seemed impossible to avoid triggering 'selective default' with private sector involvement (PSI) in a debt rollover and that the ECB appeared to be questioning the merits of pushing for PSI for little gain.
If PSI triggered a default rating, the Greek government would ultimately be responsible for underwriting the Greek banks -- which could potentially no longer tap ECB funding -- a scenario that would leave euro zone governments with a bigger problem as Athens could not afford to underwrite its banks.
"It could be the choice between not having, say, 10 billion euros of private sector involvement through bond rollovers or the need to underwrite the whole Greek banking sector, which costs more than 10 billion euros," Matthews said.
The ECB could, alternatively, ignore the ratings agencies altogether and base its assessment of Greek bonds on the readout it gets from the troika dealing with Greece's debt crisis -- its own staff, the International Monetary Fund and the European Union.
"I trust above all the judgment of the three institutions" overseeing the bailout, German Chancellor Angela Merkel said on Tuesday, stressing that Greece's international lenders must ensure they do not lose the ability to make their own judgments in the face of rating agency warnings. (Editing by Mike Peacock)