“The risk management of the ECB is actually quite careful and [we] should be given credit for this.” With these words, European Central Bank governor Mario Draghi in March sought to allay fears over the use of the central bank’s balance sheet to shore up eurozone-banks' solvency, through the progressive expansion of the pool of eligible securities in the ECB’s refinancing operations with commercial banks. Fast-forward to this weekend: the disclosure that the ECB is investigating whether it broke its own collateral rules on Spanish treasury bills is likely to ignite German fears of the ECB’s ‘mission creep’, and its risk controls, more generally, say analysts. Over the weekend, Die Welt am Sonntag, a German newspaper, said this error had saved Spain €16.6 billion thanks to over-rated collateral values, compared with a stock of €80 billion-worth of 18-month bills pledged at the ECB. On Sunday, the ECB said it was investigating the matter.
The suggestion is that the central bank applied a 0.5% haircut for Spain, as per its guidelines for short-term fixed-coupon bonds rated between triple-A and A-. However, Spain is rated by the three main rating agencies as a low triple-B sovereign, which requires the ECB to apply a 5.5% haircut to Spanish treasury bills posted by commercial banks, in keeping with its valuation-haircut guidelines for bonds rated BBB+ to BBB-. By contrast, the German weekly notes that haircuts were correctly applied in the case of BBB+ rated Ireland.
“The question is: was this an error by the ECB or a deliberate watering down of collateral rules? Whatever the answer, the development is likely to elevate concerns in Germany over the steady ‘mission creep’ of the ECB,” says Desmond Supple, fixed-income analyst at Nomura.
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| Source: Reuters |
Since the eurozone crisis took root, the ECB has propped up eurozone banks – along with historically low rates and extraordinary liquidity assistance – with the aggressive loosening of collateral requirements, both by rating and asset type, for marketable and non-marketable securities. Last December’s long-term refinancing operations intensified this push to relax collateral requirements. The move has triggered German concerns – and expressed by Die Welt am Sonntag itself – that aggressive liquidity support has undermined the ECB’s balance-sheet strength and risk management, as well as its price-stability mandate, more generally, with the ECB disputing these claims by marketing the transparency of its haircut guidelines.
The ECB’s apparent failure to obey its rules will increase the political pressure, especially if it considers widening its collateral rules further, at a time when it is seeking to assume responsibility for supervising the eurozone’s 6,000 banks, say analysts.
Spain risk Nevertheless, the ECB has taken measures to reduce its risk exposures to Spain after it stopped accepting new government-guaranteed bank bonds in early July, with analysts suggesting Spanish banks have essentially run down their marketable collateral available for conventional ECB financing operations. The ECB’s apparent failure to obey its own guidelines raises the question as to whether it was benign oversight or a calculated attempt to shore up Spanish bank solvency, amid limited financing sources.
Spain’s banks rest on a knife edge, amid declining collateral values, deposit volatility, fiscal uncertainty, and a besieged investor base. Although Spanish banks have parked some €28 billion on deposit at the ECB, the bulk of this is likely to have come from the stronger banks, such as Santander, say analysts.
In July, the Bank of Spain took the unusual step of confirming that it has provided extraordinary liquidity support to local banks via the emergency liquidity assistance (ELA) facility – which is pricier than ECB funding – to the tune of €400 million.
“The ECB is unlikely to do anything that puts Spanish banks under further pressure,” says Daragh Quinn, Spanish bank analyst at Nomura. “There are essentially two options, if the German report is correct: either the ECB ignores its own guidelines – after all it has relaxed collateral requirements considerably – or Spanish banks tap the ELA.”
Spanish banks’ financing power and the ECB’s own haircut valuation will also be thrown into sharp relief if Canadian ratings agency DBRS becomes the fourth ratings agency to downgrade Spain to a BBB-rated equivalent. This would trigger a 5% increase in the haircut the ECB demands for Spanish government bonds across all maturities, intensifying calls for a Spanish government bailout, analysts say.
“The German report highlights the inflammatory nature of collateral, the shortage of which is creating instability in Spain and the eurozone, more generally,” says Supple at Nomura.
Another consequence of the ECB’s apparent move to apply at least an A- rating on volatile Spanish treasury bills – even amid Spain’s fiscal crisis – is that it creates a dispiriting backdrop for the Basel committee, which has argued that EU commercial banks have erroneously assumed some of their sovereign debt holdings are high-rated in the calculation of their risk-weighted assets. In other words, if the ECB has fallen foul of the rules, intentionally or otherwise, then it’s perhaps no surprise commercial banks have also done so.
Although the weekend’s developments are likely to shine a light on the risks to the ECB’s €3 trillion balance-sheet, analysts continue to strike a sanguine note, citing the central bank's embedded cushions before any losses would be felt.
“The ECB has different layers of protection, both with daily margin-calls and haircuts, and it will only take a loss if the commercial banks’ themselves become insolvent in the event of the Spanish government becoming insolvent,” Greg Fuzesi, JP Morgan’s Europe economist, says.
What’s more, in late-May, Lorenzo Bini Smaghi, a former ECB executive board member, told Euromoney: “the ECB’s reserves have doubled in recent years – the reserves of the eurosystem stand at around €300 billion, and it has its own risk management with respect to LTRO. What’s more, a counterparty would have to fail and the collateral it has posted has to be valued at a price lower than the haircut – two big events – before losses are felt on the ECB balance sheet.”