Thursday, January 12, 2012

ECB considering lending against loans on bank balance sheet

Harry Wilson of the Telegraph reports that the ECB is considering expanding the collateral it will accept to include the loans on bank balance sheets.

By doing so, the ECB is effectively insuring that all Eurozone banks will have access to liquidity sufficient to handle a sizable run on the Eurozone banking system.

When the Bank of England asked for public comments on using bank loan portfolios as collateral, your humble blogger suggested this only makes sense if banks are required to provide ultra transparency.

By requiring the banks to disclose on an on-going basis their current loans and the performance of these loans, market participants can assess the value of these loans.  As a result, just like for publicly traded securities, the central bank has an independent value it can use so that it doesn't lend more than the loans are worth.

Without ultra transparency into the bank's loan portfolio, lending against this portfolio involves taking on the same type of risk as buying opaque, structured finance securities.  We know that buying opaque securities did not work out well for the capital markets.

The European Central Bank is considering a major easing in the rules on the assets it will accept from struggling lenders in return for loans that could expand by more than €10 trillion (£8.3 trillion). 
Analysts at Citigroup said allowing eurozone banks to use outstanding loans as collateral to borrow money from the ECB would increase the pool of available collateral by €11.7 trillion. 
"While the details are to be decided, one principle would appear to be clear: central banks will create as much liquidity as needed to back stop the European banking system. Banks will not run out of cash or collateral," said Citigroup. 
The ECB has been discussing easing its collateral requirement and the final rules are still not clear, with a further meeting of its council expected to discuss the matter on January 26. 
The opening last month by the ECB of a new three-year funding programme for banks helped calm market fears over the eurozone banking system.


Anonymous said...

Looks like where on our way to HYERINFLATION.
But! No one cares, there is so much ignorance out there....people are hopeless.
When bank runs occur or hyperinflation sets in, maybe, just maybe they will wake up.

Richard said...

It really depends on how the central banks provide the funds to the banks. It is possible for it to be done without hyperinflation.

Furthermore, so long as the banks have access to liquidity from the central bank, it reduces the incentive for insured depositors to "run".

What you should expect to see during 2012 is that unsecured bank debt holders don't rollover their investments. The ECB will replace this funding.