The move not to accept Irish debt for repo transactions has a lot more than a symbolic effect. It means that banks cannot fund their liquidity needs through borrowing from the central bank with Irish debt as collateral.
I’m told that because Swiss regulations demand that the assets used to meet liquidity and capital requirement be repo eligible, Swiss banks can find themselves with a shortage of regulatory capital if they have too much of the excluded debt.
This not only means that the Irish debt they own is dead money—it means they won’t buy any Irish debt for the foreseeable future and may have to sell off the debt to replace it with assets that can be used to meet capital regulations.
Both Credit Suisse and UBS are subject to tighter liquidity and capital requirements under rules put in place this summer. The details of the requirements remain confidential.
The Swiss National Bank says it subjects securities to strict tests of liquidity and riskiness to determine repo-eligibility. It has some guidelines that it sets forth. Both the individual debt securities and the country itself must have a minimum bond rating from S&P of AA- or AA3 from Moody’s, for instance. That means that the ratings decisions by the agencies are far more than advisory—they more or less control whether Swiss banks can and will purchase sovereign bonds.
But the SNB also reserves the right to deem ineligible any security without further explanation. This is leading to fears that the Swiss could start turning away other sovereign debt—say that of Spain or Portugal.
If the Swiss decided to stop accepting Spain’s sovereign bonds, it would effectively prevent UBS and Credit Suisse from participating in Spanish debt auctions. Taking out these two huge buyers of European debt would drive up Spanish yields, and potentially scare off other buyers.
This is not a far-fetched possibility. At various times over the past 12-months, the SNB has turned away government paper from the UK, France, Dutch and Slovenia because of liquidity concerns with specific securities.
There’s an irony here. The debt problems of many European nations are, at least in part, caused by their lack of control over their currency. They cannot monetize their debt because they have given up their central bank’s role in governing the money supply to the European Central Bank. Switzerland has retained control of its money, preserving the Swiss Franc while so many of its neighbors gave up their national money in favor of the euro.
Now Switzerland may be in the position to threaten the stability of the euro by refusing to take sovereign debt from eurozone nations.
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