The European Central Bank faces an acute dilemma: on the one hand it needs to ensure that banks have access to adequate liquidity, but on the other it needs to prevent banks profiting unduly from central bank funding. Recent signs of banks undermining the ECB’s generous rules on collateral are worrying, and the ECB should address them promptly. What it cannot afford to do is cause a new storm in the markets. That is easier said than done.

The ECB’s rules on assets acceptable as collateral for banks’ borrowing from the central bank are broader than those of the US Federal Reserve or the Bank of England. During the credit squeeze this has meant that banks have found it easier to obtain liquidity, while at the same time allowing the ECB to keep interest rates high in its fight against inflation. A sudden and significant tightening of rules runs the risk of pushing some banks into liquidation and markets into turmoil.