In early 2010 the European Central Bank’s top brass made clear that they wanted Eurozone banks to repay a significant part of the loans that the ECB had extended to them in crisis conditions in late 2007 and 2008. According to Jurgen Stark in a speech to the European Parliament on 16th March, the expansion of the ECB’s balance sheet was potentially inflationary. So it had become necessary to withdraw ‘the non-standard measures.’
The key withdrawal measures came in late June/early July. Many Eurozone banks were able to settle their obligations to other banks without difficulty. The ECB’s longer-term refinancing facilities to all the Eurozone banking systems were €718.2 billion at 25th June. At 27th August they had tumbled to €150.3 billion. On the face of it, the ECB has gone a long way to eliminating the ‘non-standard measures.’
However, what actually happened in late June and early July was very far from being a great success for ECB planning and organization. The aim was partly to eliminate a potential inflationary threat from banks’ supposed excessive cash reserves and partly to wean the weaker banking systems in the PIGS (Portugal, Ireland, Greece, Spain) countries off their dependence on ECB funding. But, since no inflation threat existed, it was only the second of these that really mattered.
The ECB has failed to cut back on its lending to the PIGS’ banking systems. There has been a reduction in banks’ borrowings from the ECB, from about €800 billion in spring 2010 to about €550 billion now, but that can be more than explained by repayments by the (relatively) strong banking systems of Germany, France, the Netherlands, Italy and so on.
But it is not the German, French and Italian banks which have really been in trouble in the inter-bank market. Instead since mid-2007 it is the banks in the PIGS countries which have been under most pressure to borrow from the ECB. The PIGS’ banks did not have the credit-worthiness to roll over their lines in the inter-bank market in 2008 and 2009; they still do not have that credit-worthiness today. When the ECB withdrew most of its long-term refinancing facilities in late June/early July the PIGS’ total borrowings from the ECB did not go down at all. In fact, the ECB borrowings of Portugal’s banks actually rose at exactly the same time that the ‘non-standard measures’ were meant to be closed.
There is little doubt that, at present, total ECB lending to the PIGS’ banking systems stands at over €350 billion and is roughly €100 billion higher than at the start of the year. For these banking systems – the banking systems about which commentators are most worried – the ECB has been unable to replace its funding by market-based finance. Banks in the PIGS – particularly in Greece, Ireland and Portugal – are more heavily dependent on ECB support than at any time since the start of the crisis. For these banking systems the crisis – far from being close to resolution – has been intensifying during 2010. The ECB’s aggressiveness about the need to withdraw ‘non-standard measures’ has only aggravated their problems.
Governments and banking systems are necessarily inter-twined. When a central bank lends on a large-scale to commercial banks, it usually needs an indemnity from the government against loss. The credit-worthiness of governments and their banking systems are not the same thing, but they are closely related. Two key facts emerging are:
1. The PIGS’ banking systems have not – so far – been able to repay their ECB borrowings. If the banking systems are eventually unable to repay the loans, the ECB will suffer a loss.
2. The ECB has already incurred losses on the bonds it bought in May, because of the adverse yield movements already noticed.
These issues are bound to be raised by the five German professors who are testing the legality of the May support package for Greece at the German Constitutional Court. The losses that the ECB is now taking on its interventions to help the PIGS undoubtedly constitute a breach of the no bailout clause of the 1992 Maastricht Treaty. If words have any definite meaning, the German Constitutional Court must deem the ECB’s actions and the Greek rescue inconsistent with that treaty and therefore illegal. The Eurozone remains in great trouble.
Tim Congdon is the founder of International Monetary Research Ltd.