ECB liquidity and the return of National Central Banks

What’s at stake

The inability of Ireland to renegotiate the terms of its EU/IMF program and the mounting issues surrounding its banks has spurred a discussion about the substantially increased amount of emergency liquidity assistance (ELA) the Central Bank of Ireland (CBI) has granted to Irish financial institutions. The ELA facility gives all national central banks in the euro area the ability to support domestic financial institutions, over and above the assistance provided by the Eurosystem. The strengthened use of this facility could well be a new turn in the European banking crisis for it addresses some of the banking systems issues, while putting back the burden on national European governments via their respective national central banks.

Meeting the ELA: Emergency Liquidity Assistance

In an important report, Willem Buiter reports that the Emergency Liquidity Assistance (ELA) facility gives all national central banks (NCBs) in the euro area the ability to support domestic financial institutions, over and above the assistance provided by the Eurosystem. Because ELA is not an ESCB or Eurosystem function, the decision to provide assistance through ELA to a financial institution operating in the jurisdiction of an NCB lies with that NCB as stated in article 14.4 of the Statute of the ESCB. Article 14.4 also points that the costs and liabilities arising from ELA support are not pooled or shared by the other members of the Eurosystem. The Governing Council of the ECB does not actively have to approve an NCB’s ELA facility, but, according to Article 14.4, it can vote to stop an ELA facility from operating if at least two thirds of the votes cast oppose further ELA.

FT Alphaville notes that theEmergency Liquidity Assistance (ELA) 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. In another post, FT Alphaville points that the key debate is whether additional money is created outside of the remit and control of the ECB or not. There are disagreements on this point amongst experts depending on how one understands how the ECB accounts for the ELA operations. What’s clear, however, is that the ECB retains a right to veto the ELA operations.

A scenario: ECB liquidity withdrawing and more aggressive ELA use in the periphery

Nomura’s fixed income team notes that the Irish central bank seems to be gradually replacing Europe’s Central Bank as a lender of last resort. An interesting question is the possibility of the wider use of ELA in the European periphery once the ECB continues to withdraw the extraordinary liquidity measures currently in place. As banks in core Europe already enjoy uninhibited market access, any excess liquidity in the system is currently due to the use of the ECB’s facilities by banks in the European periphery, in particular Greece, Ireland and Portugal. This suggests that ELA may be used more aggressively than originally envisioned by national central banks in the European periphery, as they try to cope with the gradual termination of ECB’s extraordinary policy measures.

National fiscal authorities to bear losses

Willem Buiter argues that the use of the ELA instead of the Eurosystem facilities might be another step by the ECB to limit and reduce Eurosystem exposure to credit risk by moving it to the national fiscal authorities (since balance sheet exposure of NCBs through ELA is likely covered by State guarantees). But, to be clear, using ELA rather than the Eurosystem to provide liquidity to weak banks is viewedas a second-best solution by the ECB. Instead of having the NCBs involved in dealing with inadequately capitalized or insolvent banks, the ECB would rather like to see clear action by the national government, e.g. providing a sufficiently large European bank recapitalisation facility. In any case, it looks as though the ECB wants to go ahead with ‘concrete steps’ to reduce the ‘addiction’ of banks to ECB funding.

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