The European Central Bank made headlines on Thursday, with its request for a €5bn capital increase. The stated reason was all about covering volatility in fx, interest rates and gold prices “as well as credit risk” on other (SMP-bought) securities.
Nomura’s European rates team, however, are having none of it:
Both the timing and nature of the announcement are a bit surprising to most observers. It has been suggested this is for possible haircuts, but CBs often have negative equity due to losses on reserves (Hungary, Poland, Jamaica do so temporarily, and Czech persistently, PBC recently raised capital). Small equity capital (EUR5bn) has never prevented it from its ongoing operations. Academic papers have suggested that negative equity erodes policy credibility (see e.g., link, link and link), and this is particularly so the more unconventional the measures being taken. Seignorage revenue may not be what it once was. Finally, there is the suggestion that equity bolsters independence. The puzzle remains.
Seigniorage — issuing money — is a big deal for the ECB.
In 2007 and 2008, the eurosystem — which includes the ECB and all the national central banks — earned €135bn as seigniorage from issuing bank notes.
The ECB itself had assets of €138bn and paid-up capital and reserves of €4.1bn at the end of 2009 — which suggests a relatively small loss (but only through default or restructuring) would be enough to wipe out its thin capital base.
The eurosystem, however, had €1,850bn of assets and capital and reserves of €73bn. Despite the €5bn headline figure, Thursday’s capital raising will boost ECB coffers by just €3.49bn as non-eurozone members have not provided funds equivalent to their subscription capital, according to the FT.
Back though, to the seigniorage point. Citigroup strategist Willem Buiter had a block-buster 28-page note on eurosystem assets back in July. As he put it:
The financial assets and liabilities of the [eurosystem] omit the most important asset and liability of the bank. When we take a forward-looking view of all current and future cash-flows into and out of the central bank, and reduce these to their net present discounted values, we get the comprehensive balance sheet of the central bank …
By Buiter’s calculations, the eurosystem as a whole has another €3,258bn worth of assets (based on a 2 per cent inflation rate, real GDP growth of 2 per cent and a discount rate of 4 per cent) that can be added to its balance sheet.
In the same note, Buiter also called outlined what he characterised as a “game of chicken” currently taking place between fiscal authorities and monetary authorities the world over. Governments want fiscal stimulus. The central banks want to maintain their price stability mandate — in other words, not to inflate into infinity. At the same time they’ve been steered into quasi-fiscal action by necessity.
And at the centre of the tussle are all those glittering central bank assets.
From Buiter again:
It is apparent that the resources of the ECB/Eurosystem are worth fighting over. It is not surprising that the Euro Area fiscal authorities would rather like to get their hands right now on some of the €2.0 trillion to €6.9 trillion worth of potential capital stored up in the ECB’s comprehensive balance sheet … Of course, using the (non-inflationary) current and future seigniorage resources of the ECB/Eurosystem today means less will be available in the future. That consideration is likely to have limited impact on the desire of the political authorities in the Euro Area to shift the ECB’s payments to its ultimate beneficial owners into the present.
We’re not sure what the ECB’s capital increase means exactly. On the one hand, it’s actually transferring national central bank assets onto its balance sheet. On the other hand, there’s that persistent idea that a capital increase is paving the way for more ECB action (through government bond buying) or if not, indicative of potential losses, or risk, on its already-taken quasi-fiscal action.
Perhaps it’s just a continuation of that almighty game of chicken.
€5bn, incidentally, was the maximum figure the ECB was allowed to ask for.
Truly mysterious.
Related links:
Mechanics of a European capital flight – FT Alphaville
An outlier in central bank strength - FT Alphaville
Buiter, gangsters and euros – oh my – FT Alphaville