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Your word is my bond

12 Feb 2016 By Swaha Pattanaik, Neil Unmack

Banks’ share prices have slumped recently and yields on their bonds have shot up. Breakingviews imagines a letter from a euro zone bank chief executive to European Central Bank President Mario Draghi.

Dear Mario,

What has happened to bank shares so far this month shows markets have completely lost touch with reality. Normally you guys shouldn’t care less about short-term market moves. But the rout in bank stocks and credit is creating a dangerous spiral. My board and I think it is time for you to think big at your March policy meeting, and buy bank debt.

Ask your German colleague, Jens Weidmann, whether Deutsche Bank should be trading at 0.3 times its book value – or the Bank of France about Societe Generale’s 0.4 times valuation. Or look at the 60 basis point jump in the cost of insuring the five-year senior debt of European banks since the start of the year. If our borrowing costs rise, it risks screwing up your efforts to ensure the economy is healthy enough to generate some inflation.

I admit, it’s a big step. Buying unsecured bank debt has always been taboo for most central banks. It could make lenders more reckless, by dulling the disciplining effect of markets. And buying debt that is meant to be bailed-in could gum up bank resolution. But hear me out.

For one, banks are much healthier now and most have excess capital. Second, you could only buy bonds issued by strong banks. That should reduce the risk that you encourage reckless lending, and minimise the chance that you end up at the sharp end of a resolution. How you define strong is tricky, but the ECB should know: it’s the bank regulator. You could buy bonds issued by banks with a 2 percentage point cushion over their minimum supervisory requirements. Such bond-buying would act as a carrot for financial institutions to strive for the highest standards.

There is a precedent. The Bank of England bought corporate bonds in 2008, in the depths of the post-Lehman crisis. That seemed like heresy, but the BoE didn’t end up buying much debt anyway. Its position as a buyer of last resort made investors confident enough to not sell.

Such a purchase programme would be only temporary: it could kick in when prices are really distorted. That just leaves the risk of buying our paper. Sure, it’s unusual. But it’s safer than buying negative-yielding Bunds.

Yours from the bunker,

Gunther Der Hed



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