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comments on the new long term ECB funding policy for member banks

Posted by WARREN MOSLER on December 18th, 2011

The talk is that the new ECB longer term euro funding policy will mean euro member banks will suddenly start buying member nation euro debt and thereby ease the funding issue.

That doesn’t make sense to me. I see the 20 billion euro/wk bond purchases as possibly being enough to stabilize things, but not this.

Here’s my take:

So even if a bank officer now wants to buy, say, Italian debt out to 3 years because he can get ECB funding for that term, he probably has to go to an investment committee, so it is unlikely to happen overnight.

And the investment committees go something like this.

Investment officer:

‘now that we can get 3 year term funding from the ECB, i recommend we add to our italian debt position and make a 3% spread, which is a 30% return on equity’

committee responses:

‘why does the availability of term funding alter our current policy of reducing holdings to reduce credit risk?
what are the regulatory limits?
will the regulators allow us to own more?
what about the risk of downgrade which could force a sale?
what about repo haircuts if prices fall?
what if it’s decided Italy is unsustainable and the euro ministers vote on private sector haircuts?
how will taking on this risk affect our ability to raise capital?’

etc.

While banks may indeed buy more euro member nation debt due to the availability of the new term funding, I don’t think that new funding is enough to cause them to make that decision.

I do think the term funding will be used by banks with problems obtaining term funding to lock in the term cost of funds.

12 Responses to “comments on the new long term ECB funding policy for member banks”

  1. Sergei Says:

    Life is much easier than slow bankers arbitraging obvious things. So a bunch of much quicker hedge fund guys will come and say to bankers: we take a 3Y loan from you at 2% and post collateral for the full amount and even put some margin for the mark to market if you want to sleep better. So it is almost risk free for you, bankers, but you need to give us a 3Y loan at 2%.

    It does not mean that there will be trillions but even a hundred might do the trick. The problem with that solution is that it does not solve the problem of bank solvency and intra-eurozone flight of funds. But that is a story still in development.

    Reply

    WARREN MOSLER Reply:

    hedge funds could already do that

    Reply

  2. RsSG Says:

    I’ve already heard one large spanish bank say they won’t use the LTRO to buy their country’s debt. It seems to me that for this to work all the banks (at least the large ones) would have to participate by being it mandated by the regulators…hence we run into the monetization of debt issue the germans are so dead against. The LTRO is an excellent liquidity source given wholesale funding for the banks is pretty much nonexistent. So were back to the ECB… the only mechanism to set rate on sovereign debt.

    Reply

  3. RSG Says:

    Warren, i tend to agree with you, I’ve already heard one large spanish bank say they will not use the LTRO for buying sovereign debt. The only way it could work if it were made mandatory by the gov’t, but then why bother with the extra step and just let the ECB set rates where want. It’s the only way but it may take some time for them to figure it out.

    Reply

  4. MamMoTh Says:

    Are EZ member states not allowed to own a national bank and borrow from it at 0.001%?

    Reply

    WARREN MOSLER Reply:

    no matter who owns the bank, that bank’s lending is subject limits set by banking regulations

    Reply

    MamMoTh Reply:

    @WARREN MOSLER, and who imposes the limits and regulations, the ECB or the NCB?

    Reply

    Sergei Reply:

    @MamMoTh,

    NCBs. ECB is pretty much a shell institution which runs statistics collection services :)

  5. Art Says:

    “etc.”

    e.g., “The head of the ECB has recently said that PSI is still a viable option, once stability mechanisms and higher capital ratios are in place. Does that mean we won’t be able to hedge these positions even if it’s deemed prudent to?”

    Reply

  6. Walter Says:

    I agree with you Warren.
    These 3yrs LTROs were made to prevent problems for banks now that in q1 2012 some eur 230bn bank debts will come due.
    To use it for ez govt bonds simply conflicts with current requirements to reduce risk and rebuild capital.

    The eur 20bn/wk is enough to cover the whole ez deficit as you pointed out earlier, but there is a lot of roll over to do too. Some eur 300bn in q1 of which Italy 150bn eur. I wonder if that will go all smoothly.
    I also think that the eur20bn/wk is not going to trigger any rally now, because this info has been around for some months already.

    Reply

    WARREN MOSLER Reply:

    from what i’m hearing, seems spanish banks may be taking this as a green light to load up.

    Reply

    Walter Reply:

    @WARREN MOSLER, As discussed before, it’s not clear who/what decides in big ez banks. To my impression they’re all heavily under govt influence.
    One arm from the govt borrows and the other arm from the govt is regulator that eventually can close banks down. Better not to have them against you and ‘cooperate’ with the govt that needs to borrow…..

    Draghi gave already a hint yesterday. Sarkozy hinted already after the summit the ‘bazooka’ is now there.

    I seriously doubt those banks are going to meet their 9% cap ratio by June 2012.

    But OK in the meantime, with the help of some US housing figures we see some form of Santa rally.

    Reply

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