PARIS (MNI) – The European Central Bank, anxious to wind down its
role as lender of last resort, is working on a plan to wean “addicted
banks” off of ECB emergency funding by applying a penalty rate to those
institutions whose cash demands exceed a certain limit, according to
people familiar with the situation.
Well placed Eurosystem monetary sources told Market News
International that discussions on the subject have been ongoing for
months and are fairly far along. But no decision or announcement is
imminent, they said, because such a plan could have implications for
overall Eurozone liquidity and, in some cases, for bank solvency. Some
sticky technical details still need to be resolved.
The basic concept under consideration is a two-tier liquidity
provision system. Each bank would be able to borrow up to a certain
amount at the ECB’s fixed-rate (1.0%) refinancing operations, with
limits differing from bank to bank. Those with cash needs above their
assigned ceiling would have to pay a higher rate for the extra money.
Such a plan, if adopted, would represent a significant change to
the ECB’s crisis-time policy of providing unlimited loans at a fixed
rate of 1%, since the amount available at that rate would be capped.
One well-placed Eurozone central bank described the idea as moving
“to a system that is closer to the Fed’s discount window.” The U.S.
Federal Reserve’s discount window serves as a safety valve, allowing
banks with short-term liquidity problems to obtain funding at a rate
nearly 100 basis points above the benchmark Fed Funds rate. Generally,
the window is used only in emergency situations.
The hope is that such a change in the ECB’s refinancing regime
would make banks think harder about how much money they really needed
from the central bank and encourage them to recapitalize more
pro-actively, since that would enhance their access to money markets.
The end result would relieve the ECB’s balance sheet of collateral
securities that are not necessarily of the highest quality.
Banks with the greatest dependence on ECB funding are concentrated
in the Eurozone’s periphery, though there are a few troubled
institutions in Germany and other non-peripheral states.
At end of last year, outstanding ECB loans to banks in Greece,
Portugal, Ireland and Spain collectively totaled about E335 billion,
amounting to a stunning 61% of total outstanding ECB credit to banks —
hugely disproportionate to their weight in the aggregate Eurozone
banking sector.
Another idea under discussion, but less likely to be approved, is
that in addition to charging a higher rate in exchange for the extra
cash, the ECB could also require the banks in question to take concrete
steps to boost their core capital. But this approach is fraught with
complications — in part because the ECB’s constituent national central
banks are not the sole regulators of private banks in the Eurozone
member countries.
The discussions at the ECB are part of broader deliberations on how
best to expedite the withdrawal of the emergency measures implemented to
combat the financial crisis, sources said.
“The ECB is currently reviewing various measures that could be
taken in order to start the exit strategy process — small steps that
will be taken so that private banks will not heavily depend on ECB
liquidity,” said one senior Eurosystem official. “At the last meeting,
there was consensus that too much liquidity with very low interest rates
for a long period of time will create the wrong incentives in the
markets. Thus certain measures must be introduced.”
Other options under consideration involve changes in the collateral
the ECB accepts in exchange for loans, according to the first central
banker.
“There is a debate about collateral and what kind of collateral can
be accepted,” that official said. “You can also actively adjust interest
rates [on loans to banks] for the different financial instruments that
are accepted by the ECB and refine the types of collateral and the
degree of haircuts,” he added. “There’s a reflection on these aspects of
emergency lending and financial assistance, but I wouldn’t say a major
decision is imminent.”
The ECB’s efforts to resolve these problems come at a time when EU
politicians are involved in negotiations aimed at crafting a large,
forceful plan to tackle the debt crisis across a broad front that
includes reinforcing fiscal rules, ensuring adequate bank capitalization
and possibly enlarging the mandate of the European Financial Stability
Facility.
The outcome of discussions about broadening the authority of the
EFSF could have a direct impact on the ECB’s ability to wind down some
of the functions — including emergency liquidity operations and
sovereign debt purchases — with which it is increasingly uncomfortable,
even if it recognizes that they are still necessary.
One change under debate, for example, is to allow the EFSF to
provide short-term credit lines to banks — a move that could reduce
demand at the ECB’s refinancing operations.
More significantly, EU officials are mulling whether to allow the
facility to buy sovereign bonds. This would presumably allow the ECB to
end its own bond buying program and unload some of the E76.5 billion in
bonds it has purchased since last May. While many of the bonds are high
yielding, they also represent a risk to the ECB’s balance sheet.
Indeed, the ECB has been pushing behind the scenes for quite some
time — and more recently in public — for the EFSF to be given such
authority.
When ECB President Jean-Claude Trichet says the EFSF’s capacity
should be maximized not just “quantitatively” but also “qualitatively,”
this is what he means, explained another well-placed official with
knowledge of ECB thinking. Despite the high yields, the ECB is “very
keen to get out if it,” he said.
That view was endorsed by another well informed Eurosystem central
banker, who noted that “there’s quite a lot sitting on the ECB’s balance
sheet which the bank doesn’t want there. The best solution would be to
put it onto the balance sheet of the EFSF.”
Yet another source concurred that the ECB’s ultimate “hope would be
to hand off the task to government. But that depends on negotiations on
the EFSF. Until that is decided, and while there are still market
strains, you could not withdraw the program. The hope would be to slow
it down and eventually sell” the debt.
[TOPICS: M$$EC$,M$X$$$,MT$$$$,MGX$$$,M$$CR$,M$XXXX]
