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

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?’


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