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A new target

1 Mar 2012 By Neil Unmack

Is the Bundesbank worried about the potential break-up of the euro zone? That’s certainly how a leaked letter from Jens Weidmann, the Buba’s boss, to Mario Draghi, the European Central Bank President, reads. Weidmann is worried that collateral which the ECB is accepting from banks in return for its massive liquidity injections isn’t sufficiently good – and that strong national central banks, such as his, could be on the hook for losses.

Weidmann doesn’t talk about a break-up of the euro zone. But if he wasn’t concerned about one, it is hard to see why he might think the Bundesbank could suffer losses. After all, the ECB’s most recent operation to loosen collateral rules – on which Weidmann focuses – makes national central banks responsible for any losses. So, in theory, if the Banca D’Italia or the Banca de Espana make dud loans to their local banks, the buck (or rather the euro) stops with them.

However, all that would change if the euro broke up. National central banks in peripheral economies might not be willing or able to refund the rest of the Eurosystem for any losses. The central banks in northern Europe might then take a hit. The numbers could be large given the exposure they have to their southern peers through the so-called TARGET2 payment system. The Bundesbank’s exposure in January was nearly 500 billion euros, a matter causing concern in Germany even before Weidmann’s letter.

The Buba boss has two ideas for dealing with this potential problem: get banks to provide the ECB with better collateral as soon as the market settles down; and in the interim get peripheral central banks to give their own collateral to the core ones. The last suggestion may seem logical from the Bundesbank’s perspective. But it could go down like a lead balloon with the weaker central banks. Not only won’t they like their credit-worthiness being questioned, they would struggle to find collateral to cover anything like the entire exposure. If Weidmann really is determined to press this point, discussions in the ECB’s boardroom could get increasingly divisive, potentially hampering its ability to fight any renewed phase of the crisis.


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