The European Central Bank is shaping up to slaughter some sacred cows. The rate-setter, which has already lent more than euro 500 billion to liquidity-starved banks for up to a year, is considering offering longer-term loans. Yet, some observers, most notably UniCredit chief executive Federico Ghizzoni, also want it to loosen collateral rules.
To see why, look at the Italian banking sector. Things are already getting tight: Italian banks have borrowed euro 100 billion from the ECB, and only have enough free collateral to borrow another euro 138 billion, according to the Bank of Italy. That’s little more than the euro 111 billion of wholesale funding they need to refinance by the end of 2012. With wholesale markets effectively closed, the ECB is currently the only game in town.
The collateral famine disproportionately hits smaller banks that are providing credit to individuals and businesses; Italy’s top 111 lenders have euro 92 billion of eligible ECB collateral, while the other 650 hold only euro 46 billion. Part of the disparity is because bigger players have larger stocks of high-quality bonds. But even where the assets being pledged are similar, the ECB’s criteria still favour big banks.
Italian banks’ euro 400 billion of small business loans are a case in point. As the ECB only accepts individual loans greater than euro 500 million, many SME loans aren’t eligible. Meanwhile, for loans to be pledged to the ECB, banks need to have informed the borrower and hold independent verification of the loan’s credit quality. The likes of UniCredit will be able to provide this immediately, but a smaller lender might not. The ECB has already relaxed its rules before. In October 2008, at the height of the last crisis, it extended the pool of eligible collateral to include lower-rated credit risk, subordinated debt and non-euro assets, before partially tightening up the requirements again at the start of 2011.
The current crisis warrants similarly drastic measures. A decision to offer longer-term liquidity would provide some relief. But, it will only really help if the loans are available to those small banks that need them most.
