The ECBs apparent failure to obey its rules will increase the political pressure, especially if it considers widening its collateral rules further, at a time when it is seeking to assume responsibility for supervising the eurozones 6,000 banks, say analysts.
Spain risk Nevertheless, the ECB has taken measures to reduce its risk exposures to Spain after it stopped accepting new government-guaranteed bank bonds in early July, with analysts suggesting Spanish banks have essentially run down their marketable collateral available for conventional ECB financing operations. The ECBs apparent failure to obey its own guidelines raises the question as to whether it was benign oversight or a calculated attempt to shore up Spanish bank solvency, amid limited financing sources. Spains banks rest on a knife edge, amid declining collateral values, deposit volatility, fiscal uncertainty, and a besieged investor base. Although Spanish banks have parked some 28 billion on deposit at the ECB, the bulk of this is likely to have come from the stronger banks, such as Santander, say analysts. In July, the Bank of Spain took the unusual step of confirming that it has provided extraordinary liquidity support to local banks via the emergency liquidity assistance (ELA) facility which is pricier than ECB funding to the tune of 400 million. The ECB is unlikely to do anything that puts Spanish banks under further pressure, says Daragh Quinn, Spanish bank analyst at Nomura. There are essentially two options, if the German report is correct: either the ECB ignores its own guidelines after all it has relaxed collateral requirements considerably or Spanish banks tap the ELA. Spanish banks financing power and the ECBs own haircut valuation will also be thrown into sharp relief if Canadian ratings agency DBRS becomes the fourth ratings agency to downgrade Spain to a BBB-rated equivalent. This would trigger a 5% increase in the haircut the ECB demands for Spanish government bonds across all maturities, intensifying calls for a Spanish government bailout, analysts say. The German report highlights the inflammatory nature of collateral, the shortage of which is creating instability in Spain and the eurozone, more generally, says Supple at Nomura. Another consequence of the ECBs apparent move to apply at least an A- rating on volatile Spanish treasury bills even amid Spains fiscal crisis is that it creates a dispiriting backdrop for the Basel committee, which has argued that EU commercial banks have erroneously assumed some of their sovereign debt holdings are high-rated in the calculation of their risk-weighted assets. In other words, if the ECB has fallen foul of the rules, intentionally or otherwise, then its perhaps no surprise commercial banks have also done so.
Although the weekends developments are likely to shine a light on the risks to the ECBs 3 trillion balance-sheet, analysts continue to strike a sanguine note, citing the central bank's embedded cushions before any losses would be felt.
The ECB has different layers of protection, both with daily margin-calls and haircuts, and it will only take a loss if the commercial banks themselves become insolvent in the event of the Spanish government becoming insolvent, Greg Fuzesi, JP Morgans Europe economist, says.
Whats more, in late-May, Lorenzo Bini Smaghi, a former ECB executive board member, told Euromoney: the ECBs reserves have doubled in recent years the reserves of the eurosystem stand at around 300 billion, and it has its own risk management with respect to LTRO. Whats more, a counterparty would have to fail and the collateral it has posted has to be valued at a price lower than the haircut two big events before losses are felt on the ECB balance sheet.