Yesterday we reported that the freeze in the Europe repo, asset backed paper and money markets is a broad indication that the shadow banking system - the primary conduit to broader disintermediated financial stability or in this case distress - on the continent has now locked up, which means that the three traditional bank transformations of risk, maturity and liquidity now have to be undertaken by the very non-shadow banks whose existence relies day to day on the ECB and the Fed, without any 3rd party market intermediaries (incidentally we are looking forward to tomorrow's quarterly update of the US shadow banking system and will post promptly). Today, the ECB has just confirmed our worst fears, in that the shadow situation is likely worse than expected. From Bloomberg:
- ECB SAID TO CONSIDER LOOSENING RULES ON ABS AS COLLATERAL
- ECB SAID TO PLAN LOOSENING OF COLLATERAL CRITERIA FOR LOANS
- ECB SAID TO CONSIDER TWO-YEAR LOANS FOR BANKS
- ECB SAID TO LOOK AT ALLOWING MORE UNCOVERED BONDS AS COLLATERAL
Incidentally none of these announcements were unexpected: Goldman predicted they would all happen (odd how that happens).
More from Bloomberg:
The European Central Bank may announce a range of measures tomorrow to stimulate bank lending, said three euro-area officials with knowledge of policy makers’ deliberations.
Options on the table include loosening collateral criteria so that institutions have more access to cheap ECB cash and offering them longer-term loans to grease the flow of credit to the economy, said the officials, who spoke on condition of anonymity because the discussions are private. Two said an interest rate cut is likely, with only the size of the reduction to be determined for the monthly decision tomorrow.
And here is what the market wanted NOT to hear:
The ECB is focusing on getting banks lending again rather than increasing its government bond purchases to fight Europe’s debt crisis. The central bank’s insistence that governments take measures to restore investor confidence appears to have paid dividends, with Italian and Spanish yields plunging after Germany and France agreed to move the 17-nation euro area toward a fiscal union.
The ECB has indicated it will act to prevent a credit shortage as this falls within its monetary policy remit.
Policy makers may seek to broaden the pool of eligible collateral for ECB loans by loosening rules governing the use of asset-backed securities, the officials said. They may also increase the amount of uncovered bank bonds that can constitute a lender’s collateral portfolio from the current 10 percent limit, they said.
The ECB is already lending banks as much money as they want against eligible collateral for periods of up to a year. It is likely to add two-year loans to its arsenal, two officials said.
While a three-year loan has been discussed, it is unlikely at this stage, they said.
One official said longer-term loans might encourage banks to lend to companies and households, and they would also help financial institutions meet new Basel rules on holding longer- term liquidity.
As a reminder: liquidity stopgaps only make the insolvency gangrene even worse as it allows banks to NOT address the underlying issues and mask the symptoms. But everyone knows that by now... Or should.