Sunday, November 4, 2012

ECB under fire for lending against suspect collateral

The Telegraph reports that the ECB has come under fire in Germany for lending to Spanish banks at preferential rates against suspect collateral.

Regular readers know that central banks have been lending at preferential rates against suspect collateral since the beginning of the financial crisis.

Central banks have done so in violation of Walter Bagehot's dictum:  lend against good collateral at high rates of interest.  Instead, central banks have lent against suspect collateral at extraordinarily favorable interest rates.

I say this because central banks have accepted the height of suspect collateral in the form of non-government guaranteed structured finance securities as collateral.  Everyone knows these securities cannot be valued as their disclosure leaves them resembling a brown paper bag where the value of its contents can only be guessed at.

I say this because no central bank charged a premium for the money it lent to a bank.  This is not surprising as doing so would not have resulted in bailing out the banks and preserving banker bonuses.

European Central Bank (ECB) officials are investigating claims that they have blundered and advanced money to Spanish banks on generous rather than penal terms. 
It is thought they may have breached the tough austerity sanctions imposed on a beleaguered economy, making it easier for the government to resist pressure for a full scale bail-out. 
German newspaper Die Welt am Sonntag, citing the results of its own research, said Spanish banks had borrowed funds from the ECB at a preferential interest rate of 0.5pc even though the creditworthiness of the T-bills they provide as collateral should have required them to pay 5.5pc. 
The €80bn (£64bn) issue of 18 month treasury bills had been wrongly classified as carrying a top A rating when some of them were 'completely ineligible’ as collateral under ECB rules, it is claimed. 
The blunder charge has been levelled at the ECB in Germany following an investigation into the way the bank has been attempting to ease the eurozone crisis through its offer to buy unlimited amounts of debt from the states under the greatest pressure to help them reduce borrowing costs. 
“Dealings with certain Spanish government bonds casts doubt on the quality of the ECB’s risk management,” said Die Welt, reflecting German criticism of the ECB’s tactics.
This is not the first time that doubts on the quality of the ECB's risk management has been in the news.

This area of the ECB is responsible for the ECB's endorsement to an ABS Data Warehouse that will provide disclosure for structured finance securities including residential mortgage backed securities that is comparable to what is offered by the opaque, toxic US sub-prime mortgage backed securities that were at the heart of the financial crisis of 2007-08.

The endorsement was provided despite a leading buy-side regulator (the US National Association of Insurance Commissioners) setting a global disclosure standard of observable event based reporting for structured finance securities.

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