Concerns have been mounting in recent months that the liquidity schemes offered by the European Central Bank and the Bank of England are being misused by borrowers and are thwarting the recovery of market-based funding, including the MBS market. Announcements from both central banks in September addressed those concerns but their respective timing – one coming before Lehman Brothers’ collapse and AIG’s rescue and the other afterwards – has resulted in a divergence of policy.
The ECB unveiled tougher rules on September 4, which come into force in February 2009, regarding the assets banks can submit as collateral. It also increased the level of collateral required by increasing to 12% the haircut for ABS and MBS, regardless of maturity and coupon structure. Furthermore, these assets will be subject to an additional haircut, which will be applied to the theoretical value of assets through a markdown of 5% effectively an additional haircut of 4.4%.
The moves were widely welcomed as a belated response to concerns that some banks, most notably Spanish savings banks, have used the facility for funding, rather than liquidity as intended. Research from Santander shows that Spanish savings banks accounted for 4.4% of the funds borrowed from the ECB in the year to date compared with 0.9% in 2007. Spanish non-saving banks borrowed 5.6% of the total compared with 4.6%. Both types of institutions have suffered from the real estate crash in Spain.
The BoE was widely expected to follow the ECBs lead and curtail or even scrap its Special Liquidity Scheme, which enables banks to swap RMBS and ABS for nine-month government bonds. However, the unprecedented market turbulence in the weeks leading up to the announcement following the effective nationalization of Fannie Mae and Freddie Mac, the collapse of Lehman Brothers and Bank of Americas purchase of Merrill Lynch resulted in an extension of the SLS for three months.
Despite the reprieve for the SLS, observers are in no doubt that neither the ECB scheme nor that of the BoE is a panacea for the lack of market funding public MBS markets will have to reopen if lending is to recover. "The Bank of England and ECB schemes can never take up the slack of the securitization markets," says Roberto Henriques, financial analyst at JPMorgan in London. "[Eventually] there is likely to be a scaling back of the liquidity provisions provided by the Bank of England and the ECB in order to wean banks off cheaper liquidity and force them to engage with the primary market."