Sorry for the lateness and shortness of today’s post, I’m not feeling the best.
There was little economic news from Europe overnight due to the media concentration on the LIBOR scandal. Of note were the continuing rumblings from Finland around collateral and obligations. As I mentioned yesterday in morning links, Finland appears to be once again struggling with exactly what it has signed up for under various European treaties. Finland recently threaten to block the ESM from purchasing bonds in the secondary market but as far as other nations are concerned that is an impossibility:
Spain’s Economy Minister Luis de Guindos said today that the two countries won’t be able to block Spain from receiving aid via the euro region’s permanent rescue fund.
“There is a fundamental point in the ESM and that is that decisions are taken with a qualified majority, not unanimously,” de Guindos told journalists in Madrid. “I don’t want to go into calculations but Holland and Finland won’t have the capacity to block an agreement.”
The Bloomberg article and the Spanish minister both mentioned that the Dutch were also in on the blocking action, but this may have been a misreport because their senate had no trouble approving the ESM overnight.
More importantly, as DFM mentioned this morning, there was also some news ( full statement below) from the ECB with a surprise change in collateral rules for state-backed bonds:
The following Article 4b is inserted in Decision ECB/2011/25: ‘Article 4b
Acceptance of government-guaranteed bank bonds
1. Counterparties that issue eligible bank bonds guaranteed by an EEA public sector entity with the right to impose taxes may not submit such bonds or similar bonds issued by closely linked entities as collateral for Eurosystem credit operations in excess of the nominal value of these bonds already submitted as collateral on the day this Decision enters into force.
2. In exceptional cases, the Governing Council may decide on derogations from the requirement laid down in paragraph 1. A request for a derogation shall be accompanied by a funding plan.’.
You can find the reference ECB/2011/25 decision here.
I think this move can be viewed in 3 ways:
1 ) It is dangerous madness caused by the internal friction within the ECB governing council.
Spain and Italy have relied heavily on these instruments to support their banking systems and they were a significant part of the liquidity strategy under the ECB’s LTRO program. Collateral shortages were a major area of concern in parts of European banking system which were nullified by the lowering of collateral requirements and the LTRO. Capping this type of collateral has the potential to de-stabilise the banking system as collateral concerns again raise their head. Although it isn’t clear from the statement this could also potentially effect Emergency Liquidity Assistance (ELA) programs that countries such as Ireland and Greece have used heavily in order to support their banks.
2 ) It is a pre-emptive move by the ECB to soften up national governments for the pending regulatory oversight that they can expect as an outcome from last week’s summit.
From Dow Jones newswire:
The European Central Bank fired a shot across the bows of the Spanish, Italian and Cypriot governments Tuesday, tightening its lending conditions in what seems a foretaste of the more active role it will soon have as regulator and supervisor for the euro-zone banking system.
In a brief statement on its website, the ECB said it would cap at current levels the amount of government-guaranteed debt that banks can post as collateral in return for its loans.
Banks in more and more countries of the euro zone have become reliant on ECB loans to fill their funding gaps since the crisis began four years ago. They have also been increasingly reliant on bonds issued by themselves, but guaranteed by their home governments, to use as collateral for such loans.
The central-bank ruling comes at a crucial time for many of the region’s stressed banks, which have to meet temporarily tightened minimum capital requirements from the European Banking Authority as of June 30. A number of banks have failed to meet that deadline, forcing them to turn to their governments, which haven’t yet finalized their plans
Section 2 of the ECB’s change gives some hint that the ECB is willing to keep the existing arrangement going but only if it can become involved in regulatory oversight and action to determine prudential action. The meaning of the term ‘funding plan’ is important here.
3 ) It is a jawboning operation by the ECB to force national governments to ratify the ESM/fiscal compact. A long bow maybe, but the amendments state that these changes only matter for public sector entities “with the right to impose taxes” which doesn’t include either the EFSF or the ESM. As I mentioned earlier in the week, the fiscal compact is intertwined with the ESM and these changes potentially close down back-door funding to banks via the ECB.
That being the case I don’t think it is unfair to surmise that the ECB understood that this change would put pressure on national governments to ratify outstanding economic treaties.
Time will tell which one, or all, of these things it is. But there is no doubt of the importance of those two short amendments.