ECB Moves From One Set of Collateral Rules to Many
As struggling European banks seek financial lifelines by borrowing from the European Central Bank, individual central banks in the euro zone are expanding the type of assets banks can pledge to tap the loans. But not all collateral is created equal.
Seven of the 17 euro-zone central banks are crafting rules that will increase the diversity of assets that banks are permitted to pledge, allowing firms to borrow as much as €200 billion ($264 billion) more cash. In an aspect of the plan that is drawing scrutiny, each central bank is tailoring its collateral requirements to the needs of the banks it oversees.
The result is a hodgepodge of collateral standards across the common-currency area. The rules differ from country to country and appear designed to meet the needs of their domestic banking industries; banks in Spain might be able to pledge foreign loans as collateral, while French banks will be able to pledge residential mortgages, for example.
"This latest decision represents a significant step backward from a common monetary, credit and liquidity policy in the euro area and from an integrated financial market," said Willem Buiter, Citigroup's chief economist.
ECB President Mario Draghi said the looser rules were designed to help collateral-squeezed banks to continue lending to businesses, and he played down the risks.
But by making it easier for banks to borrow funds, European central banks are assuming greater risks with their lending, analysts say. In addition, they say, the changes mean weak lenders are more likely to grow addicted to the central banks' cash.
The new rules come as the ECB has already assumed the role of lender of last resort to hundreds of European banks. Last December, the ECB doled out €489 billion of low-interest, three-year loans to more than 500 banks. The central bank will offer another batch of the loans at the end of February. Banks are expected to borrow hundreds of billions of euros.
The new policy will leave individual central banks on the hook for potential losses stemming from some ECB loans. That is a break from the tradition of applying such rules uniformly and sharing any losses across the euro-zone system.
Until now, the ECB has only allowed banks to put up a narrow range of assets to serve as collateral for those loans, which it applied uniformly. Eligible assets included large government-issued or -guaranteed loans and securities.
But banks in some countries were exhausting their pools of eligible collateral. To ease the strains, the ECB announced late last year that it would relax some of the criteria by permitting individual national central banks to change the collateral rules.
Late last week, seven national central banks—in Austria, Cyprus, France, Ireland, Italy, Portugal and Spain—said they had decided to loosen their collateral requirements, after receiving the blessings of the ECB's governing council. The other 10 euro-zone central banks kept the previous rules intact.
To guard against risks associated with some types of collateral, the ECB traditionally imposes "haircuts" on the assets. With the new collateral, the average haircuts will be 60% to 70%. If a bank pledges $1 million of one type of loans as collateral, for example, it might only be worth $400,000 in ECB loans. National central banks haven't disclosed specific haircuts.
Analysts said they had expected a uniform set of collateral rules across the euro zone and were surprised by the divergent types of collateral that national central banks will now accept.
"It's a mess," said Robert Noble, a banking analyst in London with RBC Capital Markets. The European central banks are taking "a lot more risk in collateral terms. There's now eight different monetary policies depending on what suits your banking system best."
ECB officials acknowledge the new risks, but play them down.
"Yes, it means that we take more risk," Mr. Draghi said. "Does it mean this risk has not been managed? No, it has been managed, and it is going to be managed very well because there will be a strong over-collateralization for these additional credit claims."
In a break from the traditional euro-zone policy of sharing losses across the euro zone, the ECB has said that any losses arising from the looser collateral will be borne by individual national central banks, which are essentially branches of the ECB, rather than by the ECB itself. The goal, analysts and some central bank officials say, is to shield countries from having to swallow losses arising from other countries easing their rules.
The moves by individual central banks were crafted to accommodate the peculiarities of their countries' domestic banking industries, according to central bank officials.
France, for example, will now accept certain residential mortgages as collateral, enabling the country's lenders to tap into their deep pool of real-estate loans. The Bank of France also will permit assets denominated in U.S. dollars—a victory for French banks sitting on hundreds of billions of dollars of such assets thanks to their lending to the shipping and aircraft industries.
France's biggest bank, BNP Paribas SA, was holding $305 billion of U.S. dollar assets as of Sept. 30, representing nearly 30% of its balance sheet. A BNP spokeswoman declined to comment.
Ireland and Portugal won't only accept residential mortgages as collateral but also other unsecured consumer loans, which could include assets like credit-card debt. The Portuguese central bank said that the loans "shall not be subject to minimum credit quality requirements." Italy will let its banks post as collateral leasing and factoring contracts it has with businesses.
Spain said it might start accepting foreign loans that aren't subject to Spanish law. Analysts said that could open the door to Spanish banks with big operations in Latin America and the U.S. pledging assets from those geographies. As of November, more than 11% of the assets in the Spanish banking sector were to non-Spanish borrowers, although not all of those assets would qualify as collateral, according to the Bank of Spain.