Behind closed doors at the ECB | FT Alphaville

Behind closed doors at the ECB

The following is a guest post written for FT Alphaville by Shahin Vallee, an economist at BNP Paribas:


It is becoming widely known in informed circles that the European Central Bank (ECB) formalised actionable agreements for proper FX swap lines (euro vs local currency) with the National Bank of Hungary and the National Bank of Poland in October 2009.

The agreements, however, were never made public.

Nevertheless, they do represent an important shift in the ECB’s liquidity provision policy towards acceding eurozone members. Most importantly, they replace the ‘liquidity lines’ the ECB instituted over the crisis — which created a somewhat two-tier system when it came to the central bank’s liquidity provision at the time

When the ECB turned its back on central Europe

The ECB’s previous ‘liquidity lines’ treated the two CEE central banks in question as commercial banks in the eurozone; allowing them to repo eligible ECB collateral in return for euro cash.

But the facility failed to boost the supply of euros to the countries because it only ever offered to improve the liquidity of official reserves already held in eligible securities. It didn’t allow for the banks to swap locally-denominated securities for euro cash.

This contrasts somewhat with the actions of the Swiss National Bank (SNB) which offered the same two CEE economies bona fide swap arrangements from the offset, albeit restricted to the exchange of euros for Swiss francs.

Ironically, though, both policies collectively heightened the negative euro liquidity situation in the region, as both the National Banks of Poland and Hungary were forced to give away euros in exchange for Swiss franc liquidity, which was equally badly needed by their domestic banking systems.

All in all, the policies highlighted a poor degree of coordination between the ECB and the SNB over the course of the crisis, seemingly to the detriment of CEE countries stuck between the two central banks.

When compared to the US Federal Reserve’s approach — which acted swiftly to address the problem of dollar shortages in emerging economies — the ECB’s reaction to euro liquidity shortages in neighbouring and euro-acceding countries seems all the more striking.

The Fed agreed to formalise $30bn worth of swap lines to the central banks of Korea, Mexico, Brazil and Singapore only a month after agreeing jumbo swap lines with the ECB, SNB, Bank of England and Bank of Japan, in September of 2008.

In hindsight, these were seen as having played an important and stabilizing role for those economies, and emerging markets at large (see the recent literature on the issue: Shambaugh, Obstfeld and Taylor (2010), Aizenman (2010) and Goldberg, Kennedy and Miu (2010)).

The ECB, on the other hand, only reacted with the offer of liquidity lines after coming against stiff internal pressure from the central bank of Austria, and externally from the National Bank of Hungary.

The Bundesbank, though, did not make the concession easily. A coalition in the governing council led by Governor Nowotny of the Oesterreichische Nationalbank, followed by the Banque de France, had to fight hard to get the arrangements approved.

The ECB, meanwhile, argued it was better to supply euro liquidity indirectly to CEE economies via the eurozone banks that had sizeable CEE operations in the countries. The idea being that these banks would be much more effective at channeling the liquidity where it was needed.

While the banks eventually did do that, they dispersed that liquidity at a much slower pace than the emerging national banks that tapped dollar swap-lines directly.

Clarity, Consistency and Transparency

Beyond the issue of effectiveness, meanwhile, there is also the ECB’s approach to the issue of clarity, consistency and transparency to consider.

It was never clear why the ECB refused formal FX swap lines to CEE countries in the first place, nor why it preferred those strange ad hoc liquidity lines anyway. In private conversations, ECB officials mentioned operational risk as a key hurdle, which was in fact a politically correct way of saying that they were uncomfortable with accepting forint or zloty on their balance sheets.

Although, in a currency swap, the main risk that the counterparty takes on is that of currency convertibility, which in the case of all EU countries was virtually nil since the EU treaty prevents capital controls and limits convertibility risk (Art 64 TFEU). There was also an issue of consistency since the ECB provided formal FX swap lines to two other EU countries: Denmark (an ERM2 country) and Sweden (a non ERM2 country) but refused to do so with Latvia (an ERM2 country as well) and other non ERM2 CEE countries.

The policy justification for those choices was and remains murky and is based on the untold willingness to give enough euro liquidity to the Swedish Riksbank which could eventually swap it back to the Bank of Latvia, or to Swedish commercial banks invested in Latvia without the ECB taking direct exposure to the Bank of Latvia.

Last, with the recent agreement struck with the National Bank of Poland and the National Bank of Hungary — which we expect to be made public in the central bank’s annual reports to be released at the beginning of April — the ECB not only adds to its inconsistency by reversing a decision it only took a year ago, it shows a lack of transparency that most central banks in developing nations would be embarrassed to display.

In comparison, the Fed came under public pressure to release detailed information about its swap lines, and started doing so in June 2009, providing monthly breakdowns of the amounts drawn by each central bank:

The ECB’s failure, therefore, is not only to have tragically let down non EMU EU members during the crisis but to have ignored the fact that, as a central bank issuing a currency that intends to be a global reserve currency, it does not only have duties towards the eurozone but also towards the world at large, and in particular towards those countries that aspire to join the euro at some stage.

The ECB’s turn-around on the issue of FX swaps to CEE countries coming after the peak of the crisis and in the silence of the cold corridors of Frankfurt, meanwhile, reveals a much more profound failure: a failure of transparency, as information and policy justifications are still withheld from the public.

An ECB spokeswoman declined to comment on the matter to FT Alphaville.