Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

The ECB’s Smart Moves

European Central Bank

A couple of weeks ago, the European Central Bank announced a bunch of extraordinary moves. Banks would be given access to much longer-term credit facilities and have their reserve requirements cut, while the type of collateral that can be used for borrowing from the central bank would be expanded.

Mario Draghi, the head of the ECB , gave a speech in Brussels this week explaining the plan. You can read Izabella Kaminki’s fine commentary on the speech here.

There will no doubt be some caterwauling about the ECB conducting a bailout of the banks — a “backdoor bailout.”

What’s important to remember here is that the ECB is indeed monetizing debt, but not in the usual sense of that phrase. It is allowing banks to trade in a wider variety of credits for euros or dollars. This is an important and smart step because, as I’ve explained elsewhere, the European banking system was undergoing a major monetary contraction.

When sovereign debts that were once treated as “money good” suddenly get severely discounted, banks run into trouble. Lending dries up as banks find they cannot access international money markets because their collateral is deemed too low-quality.

What’s called for here is regulatory forebearance — allowing the reserve ratio to decline. There’s no need to encourage further deleveraging just to meet a regulatory hurdle.

More importantly, the central bank needs to replace the lost money with new money, which is what the expansion of collateral types accepted does.

It’s nice to see the ECB reacting intelligently to this crisis.

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