Speculation about a reprise of an asset-purchase programme and/or the introduction of a tiered deposit rate has been rife, as the market attempts to second-guess what conventional and unconventional tools ECB policymakers might be considering in order to achieve their monetary goals of achieving inflation rates to levels below, but close to 2% over the medium-term.

The ECB continues re-investing maturing securities rolling off the asset-purchase programme that ended in December. But clear hints of further stimulus have re-awakened pre-existing concerns that the ECB may run up against its 33% single-issuer and issue (ISIN) limits in some public-sector issuers as well as the 70% limit in the corporate sector programme in any resumption of buying.

On the sovereign side, there has been talk that the limit could be breached via disenfranchisement provisions in collective action clauses. But in practice this is likely to be more complicated under Euro CACs, where national central banks and the ECB are legally enfranchised to vote for or against proposed debt modifications, so there would be need to waiver arrangements or an increase in the self-imposed 33% limit.

There are questions about how much room-for-manoeuvre the ECB will have if it restricts its private-sector asset-purchases to eligible investment-grade corporate bonds. This and the large size of the FIG bond market relative to the non-financial segment have boosted the idea that the ECB should add collateral-eligible senior unsecured bank debt to its armoury to widen the impact of its monetary operations.

Having a buyer of first resort would have nominal efficacy as a means of ensuring banks had ready access to funding, especially weaker banks in slower-growth economies or economies prone to political event-risk volatility. And particularly as the ability of banks to operate profitably as rates shrink and net interest margins disappear becomes more difficult. But funding is not an issue in today’s climate.

“The ECB buying bank bonds won’t happen,” Dierk Brandenburg, team leader for financial institutions at Scope Ratings, bluntly stated. “Central banks may have advanced liquidity against very low-quality collateral as part of crisis-resolution, for example as emergency liquidity assistance, but I can’t think of a single instance where a central bank has ever done this as part of its monetary policy operations; not even the Bank of Japan.”

Brandenburg’s doubts are echoed by Marco Troiano, Scope’s deputy head of financial institutions. “Mario Draghi’s hints at further stimulus may have given the markets a dopamine hit, but the problem is that preferred and non-preferred senior unsecured bank debt is bail-in-able in resolution, and the ECB is the institution tasked with making the call on banks being ‘failing or likely to fail’ and pushing a bank into resolution. That is a conflict of interest and could harm the ECB’s reputation as bank supervisor,” Troiano said.

Those who support the idea underplay the natural conflict of interest that Troiano references, suggesting legal and operational work-arounds can be found. But it’s not just an issue of conflict of interest. “Banks don’t need it,” Troiano asserted. “The ECB can already buy covered bonds, and if banks need more funding, they can use TLTRO. Funding is not a concern for the sector.”

“Banks may welcome an unexpected buyer for their MREL debt, but this is even less likely as the ECB would end up as the holder of last resort of European bail-in capital and defy the point of resolution i.e. to avoid public bailouts. The role of the central bank is to provide liquidity to solvent banks and MREL is designed to be loss-absorbing capital, not liquidity.”

Given that the rising cost of excess liquidity will be a much bigger problem for many banks, particularly in core Europe, introducing a tiered-deposit rate would be a much more sensible way of supporting banks.

From a monetary policy point of view, Brandenburg appreciates the ECB’s need to be able to expand its balance sheet but says bank debt is probably not the place to look. Running counter to the concerns of those worried about the ECB getting close to hitting issue limits, covered bond and corporate issuers may simply replace some of their other funding while locking in very advantageous levels.

An interesting question is whether the ECB might consider buying equities. While equities are not currently included in the collateral framework, there does not appear to be any legal block on including ETFs in any new APP, although it might be a controversial step.

The ECB could look to the Bank of Japan to structure any ETF-purchasing programme. The BoJ has been buying ETFs since 2010 through its various phases and iterations of quantitative easing. In 2018, it bought over JPY 6.5trn (roughly EUR 47.5bn) in Japanese ETFs tracking the TOPIX, Nikkei 225 and the JPX Nikkei 400 indices. It now owns in excess of 75% of the ETF market, making it a top 10 shareholder, indirectly, of 40% of Japanese listed companies, with aggregate purchases reaching some JPY 26trn.

The fact that the central bank owns so much of the market and has become a de facto leading shareholder in a growing number of listed companies potentially raises issues of moral hazard and governance. And operationally, the jury is out on the impact ETF purchasing has had in Japan.

The European ETF market reached EUR 760bn under management in the first quarter of 2019, according to Morningstar, which estimates it is on course to reach EUR 1trn by 2020 and potentially EUR 2trn by 2024. Around two-thirds of the current market references equities, so purely from the perspective of available assets, this would give the ECB an immediate buying universe of up to EUR 500bn. 

Author: Keith Mullin:  k.mullin@scopegroup.com