ECB close to insolvency, says report
The European Central Bank is perilously close to becoming the most high profile victim of the global credit crisis yet.
With exposure to struggling eurozone debt worth an estimated €440bn, the ECB’s assets would have to see a fall in value of just 4.25% to make it insolvent.
The role of the ECB in the ongoing eurozone and banking crisis has been significantly understated, says a new study by Open Europe, a London-based think tank. “Although not all these assets and loans are ‘bad’, many of them could result in serious losses for the ECB, should the eurozone crisis continue to deteriorate. Many of these assets are extremely difficult to value.”
The report says: “Overall, the ECB is now leveraged around 23 to 24 times, with only €82bn in capital and reserves. In contrast, the Swedish central bank is leveraged just under five times, while the average hedge fund is leveraged four to five times. This means that should the ECB see its assets fall by just 4.25% in value, from booking losses on its loans or purchases of government debt, its entire capital base would be wiped out.” In 2007, Lehman Brothers was leveraged 30 times.
Hefty losses for the ECB are no longer a remote risk, says the report. Despite further bailouts from the EU and the IMF, Greece is likely to default within the next few years, which would also bring down the country’s banks. The resulting losses to the ECB are estimated to be between €44.5bn and €65.8bn. “This is equal to between 2.35% and 3.47% of assets, meaning it comes close to wiping out the (ECB’s) capital base.”
The report’s other main findings include:
– A loss of this magnitude would effectively leave the ECB insolvent and in need of recapitalisation. It would then have to either start printing money to cover the losses or ask eurozone governments to send it more cash (via a capital call to national central banks). The first option would lead to inflation, which is unacceptable in Germany, while the second option amounts to another fully fledged bail-out, with taxpayers facing upfront costs (rather than loan guarantees as in the government eurozone bail-outs).
– The ECB’s actions during the financial crisis have not only weighed heavily on its balance sheet, but also its credibility. Firstly, as a paper published by the ECB last year noted, “The perceptions of a central bank’s financial strength have an impact on the credibility of the central bank and its policy”. Secondly, by financing states, the ECB has effectively engaged in fiscal policy – and therefore politics – something which electorates were told would never happen.
– Worried about the risk of these potential losses being realised, the ECB is vehemently opposed to debt restructuring for Greece and other weaker economies. However, continuing the ECB’s existing policy of propping up insolvent banks – and intermittently governments – would be even worse for the eurozone as a whole.
– The ECB’s cheap credit has served as a disincentive to struggling banks to recapitalise and limit their exposure to toxic assets in weak eurozone economies. This creates moral hazard for banks and governments alike, at times even fuelling the sovereign debt crisis, while transferring more of the ultimate risk to taxpayers across Europe. Therefore, in its attempt to soften the immediate impact of the financial crisis, the ECB may in fact have exacerbated the situation in the long-term, increasing the cost of keeping the eurozone together for taxpayers and governments.
– Moving forward, the ECB must return to its original mission of promoting price stability and a way has to be found to get ailing banks off the ECB’s life support. This should include a winding-down mechanism for insolvent banks.