€60bn worth of covered bonds + €70bn of government bonds = €130bn of potential problem assets on the European Central Bank’s balance sheet.
A 1 per cent interest rate increase at a 3 per cent coupon with an average of seven years maturity makes just under a 5.32 per cent loss rate — which is quite a rough (but conservative) estimate by German financial consultant Achim Dübel.
Add in some forex losses and presto…
… The ECB’s subscribed (2009) capital of €5.8bn is already used up.
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This is an extreme simplification, of course. The ECB will have taken haircuts on the collateral offered up by banks and (as we learned from Monday’s Deutsche Bank report) retained claims against the local banks for the entire amount of the loans. However, a claim against defaulted banks will be worthless in a restructuring scenario.
Small surprise then, that Europe’s massively leveraged central bank is reported by Reuters to be considering raising additional capital — to use as a cushion to protect the ECB from losses on its 2010 government bond-buying programme.
Still, you could’ve seen trouble coming before then… and just by looking at the type of collateral the central bank was accepting in the emergency liquidity operations it started back at the height of the financial crisis.
This is from the 2009 ECB annual report:
A technically insolvent ECB, however, doesn’t spell immediate doom for the eurosystem. Europe’s national central banks will move to top it up if they have to.
What’s worrying is that it’s rather indicative of the dire state of some assets in the eurosystem. The ECB merely transferred this risk from the private sector to itself — boosting the reported health of Europe’s banks at its own (capital) expense. ‘Twas done in the name of financial stability of course, but not without a price.
Indeed, many people did see losses coming — even before this year.
For some good ol’ ECB blasts from the past check out Citigroup strategist Willem Buiter’s old Maverecon blog (here or here) or any of the links below.
Related links:
Some ECB refinements – FT Alphaville
The ECB as ‘liquidity monster’ - FT Alphaville
Why the ECB is a good bank with rubbish assets - FT Alphaville