As euro zone politicians scramble to bring Greek public finances back under control, the question of how much the European Central Bank will lose if they fail to avert a default has taken on greater importance.
In the past year, the ECB has bought 75 billion euros ($110 billion) in government bonds from the euro zone’s weakest economies and provided unlimited liquidity to their banks against collateral of declining quality.
The suspicion in euro zone capitals, especially Berlin, is that ECB opposition to a debt restructuring is so vehement because the financial consequences for the euro’s monetary guardian would be substantial.
“Hefty losses for the ECB are no longer a remote risk,” warned Open Europe, a London-based think-tank, in a report on Monday.
It estimates the ECB has 444 billion euros in exposures to Spain, Italy, Portugal and Ireland, as well as Greece.
“There is a hidden – and potentially huge – cost of the euro zone crisis to taxpayers buried in the ECB’s books.” Such risks discomfort the ECB, although it disputes Open Europe’s figures and assumptions.
They will weigh on its governing council on Thursday when it decides whether to continue beyond July its policy of providing unlimited loans of up to three months to euro zone banks – the consensus among ECB-watchers is that it will.
Greek government bonds put up as collateral have been downgraded to “junk” status by rating agencies ECB policymakers insist the risks on its books are not having the influence politicians suspect.
Lorenzo Bini Smaghi, executive board member, told the Financial Times last week: “Our position [against a debt rescheduling] is a position based on principle, not a conflict of interest.” The ECB would shoulder only a small part of potential losses, he pointed out.
A greater burden would fall on national central banks, which implement euro zone monetary policy.
In the end, it would be taxpayers who had to pay to recapitalise the ECB or national authorities if their reserves were wiped out. But there is a lack of transparency on exactly what risks the “eurosystem” – the ECB plus euro zone national central banks – is carrying on its books.
What are clearest are the risks involved in the ECB’s “securities markets programme”, under which it has bought government bonds since May last year. The ECB gives no breakdown, but some 45 billion euros of the 75 billion euros purchased is thought to be Greek bonds, the remainder Irish and Portuguese.
In the event of losses, the ECB has said they would be distributed according to the same formula as eurosystem profits on bank notes, which sees the ECB taking just 8 percent compared with 25 percent absorbed by Germany’s Bundesbank.
Even if the entire portfolio was wiped out, the ECB’s share of losses, at 6 billion euros, compares with 5.2 billion euros in current risk provisions.
Less sure, and potentially more dangerous, are the risks being borne under regular liquidity providing operations.
From data issued by national central banks, analysts can see where the liquidity is flowing. About 240 billion euros, or 55 percent of the total, goes to Greece, Ireland and Portugal. Relatively little is known about the collateral banks have provided as security.
“There is not a large amount of transparency,” says Nick Matthews, European economist at Royal Bank of Scotland. Open Europe argues the ECB has “allowed insolvent banks to shift many of their risky investments away from their own balance sheets and on to the ECB’s in return for loans.”
The ECB, however, says liquidity is provided only to solvent banks against adequate collateral. It denies claims that large amounts of low-quality asset-backed securities have been put up as collateral by Irish and Greek banks.
In fact, no Greece-originated ABS are eligible. Irish ABS put up by Irish banks is used to borrow only about 10 billion euros from the eurosystem.
But Ireland’s central bank and the Bundesbank have been embarrassed by revelations in Der Spiegel, the German news magazine, that they failed to apply the proper discount on some assets put up as collateral by banks they serve. As protection, the eurosystem has 81 billion euros in capital and reserves.
JPMorgan calculates that this would be sufficient to withstand the impact of 50 percent Greek debt haircut on its bond portfolio and market operations, but in a note went on: “It would be a lot more problematic for the ECB if other countries such as Ireland had to restructure.” How losses would be divided in practice is unclear.
In 2008, five banks, including the German subsidiary of Lehman Brothers, defaulted on refinancing operations. Then, the ECB governing council decided any losses would be shared among eurozone central banks according to their size.
But Mr Bini Smaghi appeared to hint that things might be different in the case of a default by a country rather than banks.
“The risk would be mainly on the central bank of the country that defaulted because the banks would be defaulting there,” he said.
The implication seemed to be that if Greece defaulted, its central bank would take much of the hit.
But it is hard to see how the ECB and other national central banks, should the crisis reach that point, could avoid severe financial consequences.