The European Central Bank (ECB) has cut off Greek banks’ access to a key source of much-needed cash, piling fresh pressure on the country’s new government to reach a deal with international creditors.

In a decision that rattled financial markets, the ECB said it would no longer allow Greek banks to use government debt, which has a junk rating, as collateral for loans.

The Greek finance ministry was quick to insist that the country’s banking system remained “adequately capitalised and fully protected”, with other liquidity channels still available.

The ECB announcement came just hours after new Greek finance minister Yanis Varoufakis held his first talks with ECB chief Mario Draghi as part of his push to renegotiate his country’s 240-billion-euro European Union-International Monetary Fund bailout.

The unexpected ECB move follows an appeal from Greece’s new leftist government to the ECB to keep its banks afloat, as it seeks to negotiate debt relief with its eurozone partners.

The ECB has now effectively refused that request, adding to Greece’s problems. Germany rejected any roll-back of agreed austerity policies.

The ECB move was a setback for Mr Varoufakis, who had earlier pledged speedy talks with international lenders on setting up a new program of reform, after abandoning its earlier aid plan.

It puts Greek banks in a difficult position.

Two Greek banks had reportedly already begun to tap emergency liquidity assistance from the Bank of Greece after an outflow of deposits accelerated after the victory of the hard left Syriza party in a general election on January 25.

The health of Greece’s big banks is central to keeping the country afloat.

The ECB move will likely feature heavily in Mr Varoufakis’s first talks with German finance minister Wolfgang Schaeuble, whose country is seen as the strongest opponent of any easing, in the terms of the massive debts Greece has built up.

Both prime minister Alexis Tsipras and Mr Varoufakis – whose left-wing Syriza party stormed to victory in elections on January 25 – have been touring Europe in recent days to build support for a new debt agreement with creditors.

Elected on a pledge to end austerity policies imposed on Greece as part of its bailout, Mr Tsipras faces the delicate task of persuading his European partners to reverse course, while ensuring Athens still gets the aid required to avoid a default.

The new government has blamed its fiscal problems mainly on the austerity shackles fixed by Germany. Mr Varoufakis could face a testing time when he meets Mr Schaeuble.

Greece said these restrictions had choked growth in an economy that has shrunk by a quarter, failed to cut unemployment that stands at over 25 per cent, and made it impossible to service a mountain of debt worth 1.75 times its annual economic output.

But German chancellor Angela Merkel tried to squash talk that Syriza could play on divisions within Europe, insisting that there were no substantial differences between major eurozone nations.

“I don’t think that the positions of the member states of the eurozone with regard to Greece differ, at least in terms of substance,” she said.

In a bid to quell Western worries over the new Greek government’s closeness to Russia at a time of Cold War-style tensions, Mr Varoufakis said that Athens would “never” seek loans from Moscow.

After talks in Brussels with European Commission chief Jean-Claude Juncker and EU president Donald Tusk, Mr Tsipras said he was optimistic of a “viable and mutually acceptable solution”.

A Greek government source said Mr Tsipras and Mr Juncker discussed plans to “jointly” create a four-year reform plan for Greece, as well as a bridging deal to give Athens time to draw up plans for reforms including on corruption and tax evasion.

But Mr Tusk said resolving the showdown over Greece’s debt was likely to be “difficult” and needed “cooperation and dialogue as well as determined efforts by Greece”.

Source: AFP/Reuters