ECB Loosens Guidelines Accepting 'Junk' as Collateral


ECB expands collateral base.

Frankfurter Allgemeine Zeitung has some of the latest:

The ECB has decided to accept securities without “A’s” as collateral. This means that loans with car loans and house mortgages as collateral can be accepted. Emergency credit extensions from CB banks normally demand gilded securities such as sovereign bonds – but who in their right mind would accept Spanish sovereign bonds?  – or toilet paper as collateral??

There are some finer points to this news:

a)      The “haircut” is 32% which means that for a loan of 1 bio. EUR the bank has to put up 1½ bio. EUR in good loans as collateral. If I recall correctly the Danish CB accepts “good loans” with a “haircut” of 20%.

b)      Once a bank has accepted a credit extension from a Central Bank (in this case ECB) its books have to some extend been opened. The mere process of putting up this collateral means that an auditor has to testify that none of these loans in the package has defaulted f.i. That means a responsibility where you can nail the bank and their auditor to the cross in the event of an untruth.

c)       As deposits flee from f.i. Spain they end up in other banks and these banks either deposit the liquidity in their CB or they are used to buy sovereign bonds (normally of short maturity). Simply put liquidity on the run has to end up somewhere. When the CB lends the money back to the banks this liquidity will in effect get security in the bank’s loans. A very roundabout way – but that is how finance works.

d)      When the banks really pres for an expansion of the collateral base – it just means they have no gilded securities left.