Operation Mars Bar

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All eyes are again focused on central banks and whether or not to push the throttle further. In Europe, one possible scenario which was circulating – and hinted by Mario Draghi during the last rate setting session – involved a potential “negative rate”. The current ECB corridor is 0% (bank deposit rate excess reserves) – 50% repo rate – 1% emergency lending rate. When Draghi mentioned to “have an open mind on all options”, speculation rose about a 25 bp rate cut and symmetric adjustments on the corridor : -0,25% (banks punished for placing money at the ECB) , a 0,25% repo and 0,75% emergency lending rate, the latter previously known as the Lombard rate. Several officials have hinted already that a negative rate might not be a successful nor a desired measure going forward. But when it comes to the Lombard rate, it seems things are moving. What’s at stake ?

Draghi already hinted several times that the traditional monetary transmission mechanism has broken down and features asymmetric symptoms : Lower interest rates don’t seem to spur lending while the problem is not identical for core and peripheral Europe. So if rate levels don’t alter the situation, how can you fix the diesel engine by adding some other grease to it ? One way is to punish banks when placing their money at the ECB (by means of negative deposit rates). Another way is bypassing the problem by softening collateral standards.

The first part of the problem is that banks still have some cleaning up to do when it comes to their balance sheets and non-performing loans. With the current soft business cycle outlook, banks are in addition afraid that new created loans might become non-performing in the medium term. And hence they are not so keen in giving new oxygen towards small and medium sized business because they consider those loans as being more risky and exposed to possible default. Finally, new Basel rules on capital requirements also make that banks need to be more careful on what and to whom they distribute the new money.

So the ECB is probably looking at the following creative solution, sometimes referred to as the Mars Bar solution : softening the collateral standards in terms of repo and marginal facility lending. It means that banks can now also send other stuff to the ECB balance sheet in exchange for money and the low tariffs also apply on this more risky collateral. At the same time, the risk is lifted from the private banks balance sheet and transformed into central bank balance sheet risk. Or what some people refer to as the phenomenon that these days central banks around the world welcome almost everything as collateral, you can even bring in Mars Bars for that matter.

So the European Investment Bank is kindly asked to join in into the game because this new measure would assume at least an approval of 1 more official EU body. And then the magic goes as follows : you create a kind of asset backed security (ABS), meaning you pool all kinds of bank loans (in this case small/medium business) and package them in 1 special purpose vehicle. The ABS is eligible as collateral for executing repo so once it enters the market, buyers of this ABS feel safe because they can at any time shift the ABS to the ECB without being refused or penalized in terms of high discount rates. And this transaction cannn be rolled over @ infinitum.

Others have hinted that the ECB should pro-actively take part in this game, meaning they should use their unlimited balance sheet in order to buy up these loans directly from bank balance sheets. This is a bit similar to what the FED did immediately after the crisis broke out in 2008, buying distressed mortgage debt f…



Econopolis

Dit artikel werd geschreven door Econopolis

op 5 juni, 2013 in ECB

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