Ireland has made an unwelcome name for itself as a country where a state and financial system have become most uncomfortably entwined — the sovereign-bank loop on steroids, if you will.
Just think of that Emergency Liquidity Assistance (ELA) which sees the Irish central bank accepting far dodgier collateral in return for loans to banks than the European Central Bank’s own-brand of repos. Or the Eligible Liabilities Guarantee (ELG) scheme — in which the Irish state guarantees certain bank deposits plus new bank debt securities issued with a maturity of up to five years. Or Irish banks issuing Ireland-guaranteed (i.e. ELG) bonds to themselves to use as collateral at the ECB’s facilities.
But did you know, Greece has been doing the exact same thing for many months?
Here are JP Morgan quants talking about both the Irish and Greek developments back in January:
Irish banks have recently issued €18bn of notes backed by government guarantees with the aim of replacing expensive ELA funding from the Irish Central Bank (at the ECB’s marginal lending facility of 1.75% plus a penalty) with ECB funding at 1%. This replacement is likely to be reflected in the end- February financial statement of the Irish central bank. As of the end of January, Irish banks borrowed €126bn from the ECB (down €6bn from December) and €51bn from the national central bank’s ELA (unchanged from December).
The issuance of state guaranteed notes not only allows Irish banks to unwind their ELA dependence and reduces the cost of borrowing from central banks, but it also protects them against rating downgrades. Rating downgrades of non-guaranteed bonds raises the haircut applied by the ECB or in extreme cases can make these non-guaranteed bonds ineligible with the ECB.
This has been a problem for Greek banks, which, at the end of last year rushed to issue €25bn of government guaranteed bonds to meet new, more punitive collateral requirements by the ECB. The Greek government has just extended state-guarantees to Greek banks by another €30bn, on top of €55bn of outstanding state-guaranteed bank bonds. It appears that one Greek bank has already made use of the new €30bn liquidity package, issuing €1bn of government- guaranteed paper this week.
To the extent that this extra €30bn is being used by Greek banks, it will mean that from the €140-150bn of collateral that Greek banks have posted with the ECB so far, almost all of it will be government-related collateral (€85bn of stateguaranteed bank paper, €45bn of Greek government bonds owned by Greek banks and €8bn of zero-coupon bonds which the Greek government had lent to Greek banks in 2008). The huge exposure to government-related collateral puts the ECB at a huge disadvantage in the event of government restructurings/defaults.
Yes indeed.
It also places a huge question mark over the possibility of Greece being allowed to restructure its debt– something which the market seems to be believe is now a ‘default’ scenario for the country (a-haha).
The problem is that forcing losses onto private bondholders at this point in time is practically impossible given that the private has become so muddled with public liabilities — those of Greece’s government, or the Greek banks it guarantees, or the ECB which seems to have assumed a hefty amount of credit risk.
It’s also why the ECB will probably have to extend its life support to guaranteed-banks even as it raises rates sometime this week. We hear, for instance, that the ECB-provided ‘medium-term funding’ which failed to emerge last week along with the results of Ireland’s banking stress tests, is still on the table…
Related links:
Greece is not Argentina – Angry Bear
Ireland’s (stylised) sovereign-bank loop – FT Alphaville
German and French banks call the shots - Irish Independent
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