The European Central Bank’s loans to financial institutions are enhancing liquidity as intended and not being used by banks to meet their core daily funding needs as feared by some analysts and participants, a study says.
However, the study, which Fitch Ratings will publish on Wednesday, warns that some banks could be structuring bonds that are riskier than those they were selling at the height of the credit bubble before the crunch began last summer.
There has been some concern that the markets for mortgage-backed bonds and other forms of debt that banks have increasingly relied on to fund lending might be restricted from making a proper recovery by the ECB’s activity.
Another worry is that banks are continuing to lend at rates that could turn out to be uneconomical once activity returns to funding markets.
Fitch will say such concerns are misplaced.
“We believe that none of the national banking systems in the eurozone are dependent on ECB liquidity to finance their day-to-day operations,” said Julia Peach, managing director and head of Fitch’s European Financial Institutions group.
“The ECB’s actions are reducing systemic banking risk, which in turn leads to greater stability for bank ratings.”
However, the agency will add that the longer the current situation endures, the greater the risk that some fears about how the system is being used by banks will materialise.
“Ongoing reliance on such sources of liquidity is unsustainable and could create dislocation of funding sources for some banks should the crisis be prolonged,” Ms Peach said.
There is an additional risk in the fact that some banks could be using the ECB’s facilities for their riskier debt and structuring asset-backed bonds that are of lower quality than they could have sold at the height of the markets.
ECB eligibility criteria have “left the door open for some banks to structure riskier transactions, both in terms of lower credit enhancement and riskier collateral profiles, than were seen when structured finance markets remained open prior to summer 2007”, says Stuart Jennings, managing director and structured finance officer at Fitch.
“There is a risk that banks will retain liquid collateral, which can be pledged with other counterparties, while using more illiquid structured assets and riskier collateral in ECB repo transactions.”
Fitch notes that Spanish and Dutch banks could be open to funding problems. It also found that a number of non-eurozone banks might have been drawing funds from the ECB through roundabout routes, particularly those in the UK.
