Tuesday, January 10, 2012

ECB provides unsecured funding to banks to keep them from failing

As European banks face a wall of maturing debt and no buyers, they are using a tool provided by the ECB to borrow on an unsecured basis. There really is no other choice for many institutions.

Joseph Cotterill at FT/Alphaville pointed out that the ECB has loosened collateral requirements so much that it now includes private bonds:
... we said the ECB’s decision in September to accept unlisted bank bonds — i.e., bonds that the banks could have issued purely to themselves solely in order to pledge them as collateral for central bank funding — was “potentially very significant”.
The process is quite simple. The ECB can't lend on an unsecured basis, but they can take a private (unlisted) bond as collateral. A bank can issue an unsecured bond to its own subsidiary and then pledge it as collateral to borrow from the ECB.  In effect it becomes unsecured funding form the ECB.

Backdoor unsecured funding from the ECB
Originally the ECB had a strict limit on how much "related party" unsecured debt they can accept as collateral (usually only 5%). But with the credit markets frozen in the eurozone and bank bonds maturing, the ECB had to relax these rules.  We pointed out last week that the ECB has little choice in the matter:
Sober Look: Going forward either the ECB expands their definition of eligible collateral further (as they have already done) or the eurozone governments, the ECB, or the IMF would need to provide unsecured financing...
That is indeed what seems to have happened. James Mackintosh (FT) describes how the ECB created a few "exceptions" to the 5% rule:
The ECB quietly increased the list of collateral it would accept by more than a third at the start of the year. Almost all the 10,599 debt instruments it added were from banks – and more than 8,000 of them from French banks. Furthermore, French banks also dominate the list of newly eligible instruments created since the rules were announced.
The problem is not close to being solved, but this loophole will allow the ECB to keep banks from failing - something the eurozone could not withstand at this juncture.

Hat tip Greg Merrill
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