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Collateral damage

25 November 2011 By George Hay

The European Central Bank is shaping up to slaughter some sacred cows. The rate-setter, which has already lent more than 500 billion euros 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 over 100 billion euros from the ECB, and only have enough free collateral to borrow another 138 billion euros, according to the Bank of Italy. That’s little more than the 111 billion euros of wholesale funding that 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 92 billion euros of eligible ECB collateral, while the other 650 hold only 46 billion euros. 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’ 400 billion euros of small business loans are a case in point. As the ECB only accepts individual loans greater than 500,000 euros, not all SME loans are eligible. Meanwhile, in order 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.


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