Update — apologies for a rather disorganised (and long) post… but we’ve finally gained information from all seven eurozone central banks who’ll accept additional credit claims under the ECB’s new rules…
Lend to an Italian small business for five years, take the loan to the Bank of Italy for ECB three-year funding… get this kind of haircut:
Update (1400 UK time) — and for Austria’s central bank (additional credit claims are the ones highlighted) the haircuts are the same…
Is that a recipe for stopping a credit crunch? (Although note the point made in comments below there’s a difference between banks not making new loans, and central bank liquidity ops allowing them to maintain existing loans on balance sheets.)
(Why not buy a government bond to pledge instead?)
The chart above is from the Italian central bank’s document setting out its terms for accepting additional ‘credit claims’. Essentially it’s expanding the eligible pool of banks’ corporate loans, etc — the very stuff of the “real economy”, though naturally not without credit risk, and difficult to value (eg. credit rating agencies won’t have looked at many loans).
Credit claims have been accepted in only limited conditions before, and with the following haircuts (click chart to enlarge — via this doc):
You can see those haircuts in the Austrian central bank’s chart above.
Compared to the BBB- credit quality floor above, the FT says these “additional” credit claims are more akin to accepting BB- assets.
The ECB’s board has only just voted to allow seven eurozone central banks to take the collateral, value the assets, and bear the default risk on them. It is not a million miles from national CBs’ emergency liquidity to distressed banks, always outside normal ECB collateral rules and always at their own risk.
The Bundesbank is apparently worried that this adds up to easy money.
With haircuts like these, really??
Although it’s still the case that we don’t know for the majority of central banks which levels of haircut will be applied, or what assets exactly will be taken. In particular what the knock-on effect might be for banks incentives’ to continue lending in this sector, and to stump up cash to meet haircuts over the lifetime of pledging them at the ECB.
We do have a headline figure of sorts…
At Thursday’s press conference, ECB President Mario Draghi said that €600bn in credit claims could be submitted as collateral at February’s LTRO, but also that it would drop to €200bn in practice after haircuts — of two-thirds, by implication — were taken. We’re not sure if that’s an average haircut figure, or how it reflects the haircuts across all seven central banks, but its scale chimes with the above.
Of course, €200bn is not exactly chump change for banks. More to the point the underlying assets are economically critical. However, surely it’s the case much of these loans are short-term in nature (think of a letter of credit, or trade finance, maybe). How will the haircuts at the short end affect their lending behaviour?
The Irish, Austrian, Portuguese, and Cypriot central banks hadn’t responded to our queries for more detail on how they will value credit claims, at pixel time. Spain’s central bank said there was no additional information available. The FT gives us the info that the Banque de France will take short-term credit claims with a default probability of no more than one per cent. Similar restrictions on assets’ “PD” can be gleaned from the few public details given by the Bank of Spain, which it seems will initially only accept PDs of 0.4 per cent or less (along with the Italian central bank).
So we’d make an educated guess that PD criteria might be roughly the same across the participating central banks. We’d note that a 0.4 per cent PD one year has been used by the ECB before, in order to rank an asset as “equivalent to” a BBB- rating. These existing rules on credit claims are the base for the new additional criteria.
However from the few hints we have, it seems the range of assets differs by country. Spanish banks can’t pledge mortgages to their central bank, but Irish banks can. Accepted currencies also vary. Austria only accepts euro-denominated claims while Spain allows those “denominated in euro or in major foreign currencies”. It would be interesting to see if we get more details later on.
If anyone’s got details on the haircuts though, send ‘em on.
Update – the Austrian and Cypriot central banks got back to us with a haircut schedule for additional credit claims, and it’s been a great help. The schedules are the same (assuming similar PDs on the underlying assets) as the Bank of Italy’s, suggesting that the haircuts are roughly similar. However Cyprus will also accept credit claims with a higher PD (1.5 per cent) than we’ve seen for other central banks, accompanied by still higher haircuts. Here’s the Cypriot haircut chart:
Further update (2200 UK time) – Information from the Irish and Portuguese central banks has also come through. The Central Bank of Ireland has said that the maximum PD it will accept on credit claim collateral is 1.5 per cent, while haircuts will be “rigorous and risk-based.” Loans denominated in sterling will also be accepted in return for further haircuts. Portugal’s central bank said its haircuts would be in line with existing ECB guidelines on credit claims, allowing for the coupons and maturities of loans.
Finally some comment from JPMorgan’s Flows & Liquidity team:
Collateral standards are being loosened along three dimensions. The first is credit quality. Heretofore the ECB has required collateral in its operations to be no lower than step 3 on its harmonised rating scale, equivalent to a probability of default over a 1-year horizon of 0.4%, or a BBB rating (with the exception of lower-rated Greek and Portuguese government bonds). Austria, France, Italy and (over time) Spain have said that they will now accept loans of credit quality step 4, equivalent to a 1-year probability of default of 1%, or a rating of just below investment grade. The Bank of Portugal will accept loans with a default probability of 1.5%, and will also accept loan portfolios without minimum credit quality requirements, but with “strict risk control measures”. The Central Bank of Ireland gave no details on default probability.
Second, the type of collateral added varies significantly across countries, depending on the type of collateral held by each banking system. For example, the extension applies to mortgages in France, Ireland and Portugal, export credit in France, and financial leasing and loans with credit guarantees in Italy.
Third, currency: the Banque de France has said it will accept USD loans, while the Bank of Spain said it would accept loans denominated in major foreign currencies.
The overall implication is a roughly homogenous reduction in credit quality across countries, mitigated by aggressive haircuts of around two thirds. To place these haircuts in context, the highest ECB haircut on coupon-bearing marketable assets is 39.5% on BBB bank bonds of over 10 years’ maturity. By way of international comparison, the Fed’s Discount Window applies a haircut of up to 56% (for sub-investment-grade land loans).
Related links:
“Safe enough to repo” – Deus Ex Macchiato
Let there be credit claim collateral – FT Alphaville
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