The European Central Bank wants out. That much is clear.
In recent months the ECB has been funding eurozone banks to the tune of squillions, with financials using government bonds, asset-backed securities and the like, as collateral. What happens to the banks though, as the ECB moves for the exit?
Deutsche Bank’s fixed income team ponder this very question in a recent note. What’s clear is that costs will be going up for Club Med countries. The current yield on short-term senior debt — even the government-guaranteed stuff — is much higher than the 1 per cent cost of financing from the ECB. And rising yields on sovereign debt won’t help matters either.
Says Deutsche:
The Bank of Spain October Financial Stability report notes that sovereign spreads tend to act as a floor applied to bank debt spreads, hence the importance of controlling those as a way in which to control funding costs. Thus while the rise in Eonia is likely to impact core banks more so than periphery, the rise in peripheral government bond spreads is greater in magnitude and hence in its impact.
The numbers — Deutsche reckons that for Ireland, Portugal, Spain and Greece a return to a pre-crisis (early 2007) average level of ECB funding would imply banks would have to shift some €82bn, €50bn, €103bn and €90bn, respectively of ECB funding to more (ahem) market-based sources.
Using current iBoxx European bank yields for the first three countries — this would mean an increase in funding cost of €4.0bn, €1.7bn and €2.5bn per year, also respectively. There’s no iBoxx data for Greece, but Deutsche figures the increase will be €4.4bn using Irish bank yields. If you compare that to 2009 GDP, the added added costs are most significant for Ireland followed by Greece, Portugal and Spain.
These are of course indicative numbers since they don’t take into account the haircuts currently placed by the ECB on certain collateral assets. Plus, as we all know by now, the eurozone banking sector has become something of a tiered system — so using average spreads will probably hide disparities between better and worse banks.
If you think peripheral banks can make up the extra cost with deposit funding — think again. Deutsche says the normalisation of policy impacts the interest rate paid on deposits too. They have to pay a premium to lure in wary customers — and the current level of deposit rates paid by peripheral banks is already at historical wides:
The ECB has gotten itself into something of a bind, then. It’s extension of unlimited liquidity has hooked weaker, peripheral financials (and some might say helped spark the current sovereign crisis) yet it’s loathe to keep funding zombie banks.
Back to Deutsche:
While understandably, the ECB do not want to indefinitely provide a liquidity line to institutions, there is a clear risk that removing it aggressively creates a credit crunch in domestic peripheral economies. So far the nuance is a gradual exit, however ideally it should be combined both with recapitalisation of the banking sector and capping of peripheral spreads so as to reduce the cost of funding.
Over to you, Trichet.
Related links:
What Goes Up… – Edward Hugh
Key euro interbank rates inch up; ECB exit eyed – Reuters
The cost of normalisation – FT Alphaville
