On Europe's 'Stealth' Money Printing
While much has been made of the public side the ECB's money-printing facade whereby any and every piece of junk collateral can be lodged with the lender-of-first-last-and-only-resort in return for shiny new Euros to spend on government bonds (or save as the case seems to be), there is another facility - the Emergency Liquidity Assistance program (ELA) - that skirts under the radar. As Goldman notes today, the ELA enables the National Central Banks (NCBs) to provide 'liquidity' beyond and above the regular refinancing operations. While the amounts are not quite on the scale of the LTRO, they are large and continue to play a crucial role in stabilizing certain segments of the Euro area banking sector. But, of course, as seems always to be the case, the unintended consequence of this temporary emergency facility is that it appears to have become a permanent facility. This consequence has two rather ugly consequences, it removes still further collateral (assets encumbered) from bank balance sheets and further delays the needed adjustment process (read deleveraging) across the banking sector.
Goldman: Focus: ELA: Providing liquidity under the radar screen
Emergency Liquidity Assistance (ELA) is one instrument through which National Central Banks (NCBs) in the Eurosystem can provide liquidity to banks beyond and above the regular refinancing operations. Although the overall amount of liquidity provided under ELA is much smaller than the regular monetary policy operations, ELA has played, and continues to play, a crucial role in stabilising certain segments of the Euro area banking sector. ELA, has, however, become now, in some countries at least, a permanent facility increasing the risk of delaying the needed adjustment process in the banking sector.
What is ELA?
National central banks can provide during a “crisis situation” liquidity on an ad-hoc basis to financial institutions in their respective jurisdiction. This assistance is part of the tool box Euro area central banks have at their disposal to fulfill their financial stability mandate. The possibility to use ELA, and thereby provide liquidity to specific financial institutions beyond the normal monetary policy operations conducted by the Eurosystem, allows national central banks to fulfill their role as lender of last resort in circumstances where the regular Eurosystem wide operations would seem to be inadequate.
Under what conditions can ELA be provided?
The decision to provide ELA is taken by the NCBs in the Eurosystem, implying a high degree of discretion on the side of NCBs. Because of this relative independence, all financial risks stemming from ELA operations remains with the NCBs and possible losses are not, unlike in the case of normal refinancing operations, shared among national central banks.
There is no Eurosystem wide operational procedure that would specify exactly under what circumstances ELA can be provided. The ECB, however, has given legal opinions regarding laws in some member countries on the role of national central banks in guaranteeing financial stability. These legal opinions give an indication what, in the view of the ECB, the broad guiding principles for providing ELA should be in theory: ELA should be only provided 1) temporarily for 2) illiquid but solvent financial institutions against 3) good collateral. Note also that ELA should not be used to provide monetary financing to governments. The experience over the last two years, however, has shown that these criteria are not necessarily always met. In some countries, for example, ELA has become a permanent source for partly refinancing the banking sector.
What is the role of the ECB in all this?
Article 14.4 of the Statue of the European System of Central Banks (ESCB) allows national central banks to perform tasks outside the normal operations “unless the Governing Council finds, by a majority of two thirds of the votes cast, that these interfere with the objectives and tasks of the ESCB”. Thus, the ECB’s Governing Council (GC) can stop a national central bank, assuming there is a sufficient majority, if it deems the actions of that national central bank to be conflicting with any Euro area wide objectives of the ESCB. The GC could, for example, decide that the liquidity provision through ELA would influence the Euro area monetary aggregates to an extent that would endanger the ECB’s price stability mandate.
How big is the amount of ELA currently provided?
ELA measures are labeled as “other claims against credit institutions denominated in Euro” or simply “other assets” on the balance sheets of national central banks. Not all central banks, however, publish this information and determining the overall amount of liquidity provided through ELA is not straightforward. Chart 1 shows ELA liquidity for several national central banks.
The consolidated balance sheet of the ESCB currently shows more than €70bn of such claims, though the total amount of ELA provided could be still higher. At least in the past the ELA provided by the Irish Central Bank was occasionally bigger than the respective figure for the consolidated ESCB balance sheet. But despite some uncertainty of the exact magnitude of ELA it is safe to assume that the regular refinancing operations of the ECB are around one order of magnitude bigger.
Why is there a need for ELA in the current full-allotment regime?
The ECB is providing liquidity in so-called full allotment mode, meaning it will fulfill any liquidity demand of banks against eligible collateral. Moreover, the ECB just recently broadened the range of eligible collateral significantly, which should, everything else equal, reduce the need for ELA even further. The fact that ELA is - despite full allotment and a broadened range of collateral – still heavily used in some countries suggests, however, that the range of collateral that is being accepted under ELA is still more generous than under the normal monetary policy operations.
It is noteworthy in that respect that the ECB decided last Friday to allow NCBs to not accept government guaranteed bank debt as collateral in regular monetary policy operations. This might again lead to an increased recourse to ELA in some cases.
What are the financial risks for other countries stemming from the ELA provision in another Euro area country?
There is no direct risk as any losses occurring due to the provision of ELA would need to be absorbed by that national central bank and the sovereign standing behind that central bank. There are, however, indirect risks. First, ELA, may be provided to insolvent banks thereby preventing the necessary adjustment in the banking sector. Second, a national central bank may suffer losses that would wipe out its capital and the underlying sovereign may not be able to recapitalise the central bank. While a central bank can in principle also operate with negative equity, such a scenario could make investors and the general public doubt the overall credibility of the ESCB on many different layers. A final indirect risk stems from the fact that ELA implies a degree of fragmentation of monetary policy in the Euro area.