ECB liquidity cliff risk

Posted by Tracy Alloway on Dec 11 10:44.

From Deutsche Bank’s Brice Vandamme — a chart to starkly illustrate the upcoming end of the ECB’s liquidity operations:
Despite the size of the ECB’s Long Term Refinancing Operation, Deutsche Bank thinks the actual impact of its end (the last one-year operation takes place this month, with the last six-month op to take place in March) will be rather limited on euro area banks. In fact, they forecast a reduction of only about 0.4 per cent of banks’ balance sheets overall.
But the issue, again, is the variance between eurozone banks. And while the banks of countries like France have relatively little dependence on ECB funding, others have rather more.
To wit, the below table showing banks by country grouping, and their exposure to ECB funding:
All of which leads Deutsche to conclude:Although the reduction in the ECB’s Long Term Refinancing Operations is large, we estimate that, net of other ECB operations, the reduction in liquidity provision should be around E200bn in 2010. This withdrawal of ECB liquidity is small in the context of the euro zone banking sector’s balance sheet of E31tr. That said, the effect could be substantial for those banks that are disproportionately dependent on ECB funding: while only 0.8% of Italian and 1.7% of French banking assets are funded by the ECB, the proportion reaches 9% in Greece and 6% in Ireland. Furthermore, we expect overall funding growth next year to be challenging for the weakest European banks, as deposit growth stays low and deleveraging pressure rises, keeping commercial banking growth prospects low.
. . .
We think that substantial purchases of government bonds were funded by banks with the ECB facility to benefit from the secure spread between government bond yield and the ECB funding cost. This trade will be unwound with the end of the extraordinary ECB facility which may negatively impact net interest margins. Once again, we see the French banks as being on the relatively “safe” side here as their holdings of government bond increased by only 13% in one year versus +70% in Spain, +50% in Greece or +27% in Ireland.
Specifically, Greece’s rating downgrade by S&P and Moody’s could threaten banks’ P&L: the ECB currently accepts collateral as low as BBB- but it will normalise its policy to a minimum rating of A- in 2011. Greece is rated A- by S&P and A1 by Moody’s with negative outlooks for both rating agencies. So Greek government bonds would no longer be accepted by the ECB as collateral if they were downgraded. This could force a sell-off and substantial losses for banks, especially Greek banks.
Of course, it’s not a Greek tragedy (or for that matter, Spanish tragic opera, or Irish dirge) just yet.
If Greece can convince the market and the rating agencies that it can genuinely improve its fiscal position, thereby avoiding a downgrade, and the loss of its government bonds’ qualification as ECB collateral, as well as find new sources of secure funding to replace the ECB liquidity ops, there might be a relatively happy ending.
If not, though, Greece is indeed looking at a substantial cliff risk.
http://ftalphaville.ft.com/blog/2009/12/11/88546/ecb-liquidity-cliff-risk/
Related links: That which the ECB hath separated… – A fistful of euros
How do you say vicious circle in Greek? – FT Alphaville
Making an example out of Greece – FT Alphaville
The ECB as `liquidity monster’ – FT Alphaville