The ECB turns into a massive backstop


Is it wise for the ECB to set up such an escape gate for entities in trouble?

Even allowing this claim to hold true, it undoubtedly undermines banking discipline. Moreover, it increases the potential for ECB balance sheet losses. The coverage granted by guarantees awarded by beneficiary banks, does not prevent potential failures from turning purported safety into unpalatable contingencies. Should that event materialise, taxpayers are likely to foot the bill.

True enough, all assets indulge into some degree of risk exposure. That’s why any sensible creditor demands high-standard collaterals for reducing the odds that all guarantors might bust all at once. Oddly enough, the ECB programmes envisage no such precautionary ring-fencing. Even worse, they discard using derivatives and other tools providing widespread coverage against sudden and unexpected wave shocks. By proving ready to bear open risks, the ECB bets rather recklessly that banks are failure-proof. Others made similar claims in past times, finding their gullibility harshly rebuked by financial discomfitures.

The lavish backstop designed by the ECB dents pressure on enhanced discipline in the banking community. As purchases become decoupled from inner risk exposure linked to the individual issuers, the ECB will treat sound and ailing concerns on the same footing. A rather questionable way to foster better financial habits, a paramount goal one would expect the ECB readily to enshrine in its new capacity as the Eurozone supervisor. A telling taste on how tricky blending banking health control with proper monetary management can become.

The ECB is confident that banks will channel extra liquidity towards enhanced credit levels for the real economy. A mere wishful thinking that stands largely unsupported by recent events. Up to now, fresh money has fed in massive public bond purchases. In the absence of any device for curbing carry trade, one is inclined to believe these liquidity injections will follow the same pattern.

Rather than enforcing discipline on banking behaviour, the brand new backstop can only dilute financial responsibility. For all his renewed calls for a credible fiscal stance, Mario Draghi delivers through these asset-buying schemes an open invitation for monetising public deficits. We fully understand, all too well, his real concern. As sovereign portfolios substantially swell, supporting their stability becomes a pivotal issue for harnessing solvency.

Failure by governments to implement a robust backstop prompts the ECB to set up a proxy. Yet, in doing so, it casts serious doubts on its willingness in enforcing full authority on banking solvency. The open risk it bears looms ahead increasing the potential exposure for taxpayers, the real last resort contributors should anything go wrong.

If the ECB gauges deflationary bouts require such unconventional measures, it should out of common sense firmly anchor asset-buying on something more than mere bets on the banking ability to honour its commitments. As details on elegility will be unveiled early next month, putting to profit this time span for revamping the warranties attached to these purchases stands as a must.

About the Author

JP Marin Arrese
Juan Pedro Marín Arrese is a Madrid-based economic analyst and observer. He regularly publishes articles in the Spanish leading financial newspaper 'Expansión'.

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