Kamis, 29 Maret 2012

Watching oncoming train wrecks - Italy and Spain will go further into recession , while Ireland ill need its Central Bank to be bailed out at some point...


Eurozone periphery governments "encouraging" banks to buy sovereign debt

Bloomberg: “There’s a moral hazard element to this,” Ken Wattret, chief European economist at BNP Paribas SA in London, said in a telephone interview. “The ECB is clearly worried that in some countries the lower the risk premium on sovereign debt, the less urgency there will be to make some changes.”
The ECB should be concerned. The Eurozone periphery governments are effectively telling their banks: don't worry about your customers for now. We ARE your main customer. Get your 1% 3-year ECB loans and buy our government debt - keep the rates low.

The banks of course are ready to oblige. After all it is a profitable trade even at these lower yields, particularly since there is no capital charge currently for banks holding their nation's government debt.

Italian banks' net purchases of Italian government bonds
and 3m moving average (Source: Credit Suisse)

Spanish banks' net purchases of Spanish government bonds
and 3m moving average (Source: Credit Suisse)

This poses two major problems for the Eurozone periphery:

1. The government bonds effectively crowd out lending to private customers (both corporate and households). There is no incentive for these banks to lend to private clients when they can just buy government paper. This will push the Eurozone further into recession.2. As the Bloomberg quote points out, the artificial lowering of yields takes away the urgency/incentives needed to get government spending under control for periphery nations.



Some Irish banks unable to qualify for LTRO are tapping Bank of Ireland's ELA

The Emergency Liquidity Assistance (ELA) are temporary loans provided by the Eurozone's National Central Banks (NCBs) to banks in their jurisdiction. These loans are outside of those provided by the ECB, such as the LTRO program. The idea was to allow for some discretion for the NCBs to help their domestic institutions in a crisis situation that is specific to that nation, as opposed to a Eurozone-wide issue managed by the ECB. Unlike the ECB's lending programs where the risk is shared by the Euro-system, the NCBs bear the risk on ELA loans. The ECB can in fact stop the NCBs from providing specific ELA assistance if it is deemed to interfere with the ECB's overall policy actions.

With the massive LTRO lending program by the ECB, one would expect that the Eurozone banks would repay their ELA loans and roll them into the ECB's 3-year loans. That seems to be what in fact happened for some nations such as Belgium, but the roll was only partial for Ireland. The Central Bank of Ireland still has some €45 bn of ELA loans outstanding.

So why would Irish banks not roll their ELA into the 3-year 1% LTRO? There is only one explanation. In spite of the much looser collateral requirements under the latest LTRO program, the collateral posted by the Irish banks under the ELA loans just doesn't qualify for LTRO. These Irish banks still need the liquidity but simply don't have the collateral the ECB would find palatable.

This is an important development to watch because it indicates continuing stress in the Irish banking system - with some banks so tapped out, they don't have enough ECB-eligible collateral. It also poses a risk to the Central Bank of Ireland that is not shared by the Eurozone (for now), particularly given that Ireland is in no position to bail out its central bank.

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