Commenter MM highlighted this article from Saturday’s Irish Times by John Kelly and Eunan King as an interesting argument in favour of the government’s current approach towards the banks and against nationalising banks. The Kelly-King duo wrote that an
advantage of the proposed Nama model is that keeping most of the banks as stock market entities enables the ECB to fund part of the Irish Government’s deficit, in a manner that provides the veneer that the central bank is not buying government bonds directly.
This is a practice prohibited under the rules governing the establishment of the ECB, because it amounts to the central bank simply printing money to finance Government spending.
I do not believe that this argument is correct. The clause in the European Treaty prohibiting monetary financing is Article 101 of the Consolidated Treaty of European Union (link here). This has two paragraphs and they read as follows:
1. Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.
2. Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the ECB as private credit institutions.
So while Paragraph 1 rules out the ECB giving loan facilities to, or purchasing bonds from, national governments, Paragraph 2 explicitly states that this does not apply to publicly owned credit institutions. As such, lending to nationalised banks does not break the prohibition on monetary financing.
Furthermore, even under the NAMA plan no central bank is “buying govenment bonds directly”. Rather, what is being proposed—whether we have a stand-alone NAMA or a NAMA used in conjunction with nationalisation of some banks—is using these bonds as collateral for loans from the ECB.
39 replies on “Publicly-Owned Banks and the ECB”
Does the Treaty prohibit individual CB of the system from buying bonds issued by other member states. Can the Irish CB buy Italian Debt and vice versa?
the important stuff is actually in the clarification rulings that have come since the main documents and Treaties were drawn up. Specifically:
“Council Regulation (EC) No 3603/93 of 13 December 1993 specifying definitions for the application of the prohibitions referred to in Articles 104 and 104b(1) of the Treaty (now Articles 101 and 103(1) of the Treaty) further clarifies the precise scope of application of the monetary financing prohibition. It specifies that the prohibition under Article 101 of the Treaty includes any financing of the public sector’s obligations vis-à-vis third parties. The above mentioned Community law provisions are therefore intended to prohibit NCBs from financing the public sector.”
I’m no lawyer, but i think the following sentance is the important one:
“any financing of the public sector’s obligations vis-à-vis third parties”
I would read this as to mean that if a bank was nationalised, and it bought debt off the government, and this debt was then repo-ed to the ECB, that this would be alright so long as the bank wasn’t purchasing the debt for the sole purpose of funding the budget deficit. As such, it would have to be seen as an honest investment by the bank in purchasing the debt, at an appropriate market rate. Essentially the ECB would require arms length decision making and pricing in the purchase of the debt.
This does throw up an interesting situation though: at the moment, the suggested funding model of NAMA is still vague. However, some of us (though not all!) have suggested that the NAMA bonds will be issued at lower coupons than comparable Irish government bonds (ie 5yr bond, L+50). Again, while i’m not a lawyer, wouldn’t this therefore suggest that this funding model WOULD work with a private sector entity, but WOULD NOT work with a nationalised bank, in regard to the legal stuff above? Or at least there could be an argument there of?
My legal non-qualifications already well established, i’d be interested to hear anyone else’s take on the subject!!
I had wanted to keep this simple. My point is that the relevant article does not prohibit lending to nationalised banks or repo operations in which nationalised banks use government bonds as collateral.
Beyond that, I don’t think there’s much point in getting into the issue of “could nationalised banks accept low interest rate government bonds in return for property loans?” because I’m not sure there would be any point in using this type of instrument if the banks were nationalised. If we owned these institutions, why not issue them proper Irish government bonds in return for their property assets?
Karl, your interpretation is correct…
“publicly owned credit institutions … shall be given the same treatment”
On a quite different tack, interesting to note recent comments from St Louis’ Bullard and the Bundesbank’s Weber
St Louis’ Bullard is arguing that a lowering of payments to bondholders in distressed outcomes would create incentives compelling them to better track risks.
In Europe, the Buba’s Weber is calling for a model which allows banks to follow an orderly bankruptcy “Eventually, large banks need an option that allows for an orderly unwinding of these banks in case of a system failure”.
Sounds sensible. But two years into the credit crunch, and these suggestions are still anathema to governments and Ireland no exception. Ireland, alone in Europe, is still debating how to rescue its domestic banks, all of them.
The real surprise with Nama is not so much that the present Irish government is looking to alleviate the up-front pain over the next year or two while protecting and preserving Irish domestic banking interests (all at the expense of a massive contingent liability for the taxpayer in later years).
The surprise is rather that the ECB acquiesces in allowing itself to be “bailed in”. The ECB may say to itself that it is playing in line with the book of rules it set up for its repo operations (this goes far beyond Treaty obligations). Yet it is still acquiescing in a bail-in. Now if European taxpayers were ever to get wind of this, and Ireland to ever again vote no to Lisbon, ….
Ciaran, I honestly don’t think this is a case of the ECB “may say to itself that it is playing in line with the book of rules it set up for its repo operations”.
The ECB has set up the current operational procedures to support the European banking system as a whole. Perhaps these procedures go beyond Treaty obligations but this isn’t territory that was envisaged. And they aren’t engage in this strategy to deliberately support a few dodgy Irish banks.
At the same time I doubt it they are too surprised that there are some zombies on the drip feed and I guess that they accept this as a byproduct—Stark’s comments can be taken as a sign that they are aware of this and not too thrilled about it.
Certainly I don’t see why they would adapt these rules to specificially exclude Irish banks.
Now, beyond that, there is an issue about the general implications of implicit subsidies in unlimited credit operations at 1 percent. But that goes well beyond the issues pertaining to the Irish banks.
sorry for going legal there, i was just trying to figure out how far a nationalised bank could push the regs before the ECB may call a halt to it.
If we were to nationalise the banks, at what stage would their liabilities become part of the State balance sheet (Anglo’s currently are not, correct?)?
Nobody can be sure but Alan Ahearn indicated in an Irish Times article that the NAMA bonds would be variable rate bonds.
My guess is these will be 7 to 10 year FRNs with 6 month coupon resets.
The latest 6 month rate Ireland has raised money at is 0.481% Adding about 110bps to 120bps for 7 to 10 year risk rather than 6 months would give an initial coupon of 1.5%.
There is no way the ECB will allow us to issue anything else.
I would guess that as with other independent semi-states, the liabilities of any nationalised banks would be off government balance sheet.
To be honest, though, I try to steer clear of the guessing what Eurostat decide is on or off a State’s balance sheet—I’m an economist not a statistician! And my attitude is that a Eurocrat saying yay or nay doesn’t really make a whit of difference in the end.
But look, any nationalised bank (including Anglo!) has assets as well as liabilities. The potential burden on the state is measured by any gap between assets and liabilities, rather than by the liabilities considered in isolation.
I used to be pretty sure that what you’re saying about the bonds was the way it was going to turn out. At this point, I can honestly say I don’t know. There are people I respect who believe that they will be rolling six-month bonds that the government will keep issuing them to the banks who, in turn, won’t trade them.
I really don’t know. And given the bizarre range of statements about these bonds given by various government ministers over the past few weeks, it’s not clear that they know either.
And sure why would we care? It’s only €54 billion in future taxpayer obligations we’re talking about. Why would the Minister bother to let us know?
Yes I quite agree… the ECB accept this carry-on as a by-product— and not too thrilled at all about it. I can especially see Stark and Weber ill at ease with some of the possible consequences (Weber’s comments above are one manifestation of that concern).
The ECB’s rules ought never overtly discriminate between national banks. That said, the ECB’s covered bond purchase scheme does have varying implications between countries. I was also intrigued by newswire stories late last year on communications by the ECB in relation to the maintenance of lines to guaranteed domestic banks, during the thick of the crisis.
If the government was going to issue 6 months T-Bills then why would we have to pay 1.5%?
And on a purely practical level why would they choose to have the risk of rolling over the bonds every 6 months when it can just issue an FRN?
Seems a little crazy and I just don’t see the upside in it for them.
Of course the government won’t shock me with again with their stupidity.
“If the government was going to issue 6 months T-Bills then why would we have to pay 1.5%?”
Good question. Two thoughts.
First, the lower rate in the NTMA auctions would have to be adjusted for what you think the rate would be if we tried to sell €54 billion of these things as opposed to the much smaller amounts auctioned lately!
Second, this is an off-market deal distorted by all sorts of political considerations. Don’t expect textbook finance thinking to explain this stuff.
Out of curiousity, does anyone know the motive or intention of that article 101?
One could be forgiven for believeing that they wanted any insolvent banks to be wound up !
So the article by Kelly-King is wrong on two fundamental points
So the article by Kelly-King is wrong on two fundamental points
1: Nationalised banks can particapate in repo’s and borrow from the discount window in the same way that private banks do, and
2: The ECB is not buying any government debt, merely allowing it to serve as collateral for repos, in the same way it always has
In other words, this is “enhanced credit support” as opposed to QE.
You mentioned that the unlimited 1% main refinancing operations are an implicit subsidy. I remeber WB from the ft writing something about this too. Could you explain that alittle bit, if you can spare the time?
wasn’t sure where to post this, but…
*ALLIED IRISH BANKS TO SELL 3-YR BONDS IN EUROS
Senior bond issuance, 3yrs, so outside of government guarantee. Pricing at L+260/265 at the moment. No word on size.
This is bizarrely positive if they can get a decent chunk away at these levels. It would be a massive sign of approval in the NAMA process and the Irish banking system going forward. It would again underscore the positives from NAMA to the funding and liquidity positions of the Irish financial system. It should also silence those who claimed to anyone who would listen that the Irish banking system wouldn’t be able to access funds outside of the govt g’tee.
pets.com was also able to attract investors for a while
inspired comment there. I forgot the mantra in here – “Anything, or anybody, pro-NAMA is to written off as folly and/or a vested interest.”
Not fair 🙂 Just a poor attempt at levity
i understand your skepticism, but you need to understand mine.
Dr Fitz – “lives in his sons basement and AIB bailed him out. Ergo wrong”
Donal O’Mahony – “waiting for a fee. Ergo wrong”.
Alan Dukes – “he’s gone native in Anglo…Ergo wrong”.
Erik Nielsen/GS – “they had to be bailed out by the US govt, and im sure they’re trying to make money somewhere off this process”
ECB – “ah sure they just want their money back”
AIB shares up – “proof the taxpayer is being screwed. We’d prefer the shares to have crashed. No chance of private capital flowing in…even though this is private capital flowing in…”
AIB bonds up – “proof the taxpayer is being screwed. They haven’t a prayer in issuing outside of the g’tee”.
Irish CDS better – “CDS is discredited, and sure everyone else has been doing even better than us (even though Greece vs Ireland has now converged by close to 20bps in the last week)”.
BoI covered bond issuance program issues outside the g’tee for the first time in around 2yrs – “sure why do they need NAMA then???”
AIB issues close to €3bn in senior bank bonds outside the g’tee, at reasonable pricing – “investors have made bad bets before. Ergo this is a bad bet again”.
So, you’ll understand my skepticism as to everybody on here giving NAMA a fair hearing. It’s only 8 days, its only a few deals, the pricing is still stretched and difficult. However its probably the first semi-sustained period of good news for the Irish financial system in over 2yrs. Its probably the first time in a couple of years that the markets, on who we are far more reliant than people are willing to admit, have actually looked at Ireland and said, “actually, that looks interesting”.
A lot of this process becomes self-fulfilling and self-healing. Confidence creates confidence. One good deal is followed by another good deal which allows for more good deals. Lisbon gets passed, a tough but fair budget gets passed and people start talking about Ireland recovering eventually rather than going broke. Investment and spending return, slowly. Job losses stop. Job creation finally returns. This is the way out of this mess, not by nationalising the entire banking industry or bringing down a government, saying no to Lisbon and threatening all out strikes at even a 1 cent cut in public service pay, all at the most crucial point in this country’s history. There’s plenty of time to ‘fix the system’ (financial, regulatory, political) when things have calmed down and the worst is behind us, but if there’s no system left to fix (insolvent and nationalised banking system, national strikes, ECB/IMF running the show, nation hopelessly divided politically), than what good are we really going to do?
That’s all very reasonable. Much of the anti-NAMA rhetoric has been agenda laden and excitable, to say the least. But your perspective is the market one: let’s get the system going again. A proposal has emerged which may do that. And, therefore, it gets the approval of the market (you, Goldman Sachs etc). All very reasonable – provided you are not an Irish taxpayer.
The reasoned voices of objection have always argued that you can achieve a market-friendly result with an amended version of NAMA that doesn’t lay all the risk on the taxpayer. That’s all really.
People from the outside have the luxury of looking and saying “that looks interesting” as they do not have to care about the cost. The people that have to care about the cost can’t avoid accepting that they have to make the best of the current situation.
Outside commentators are like brokers. They don’t mind that much who wins or loses on the deal as long as the deal is done and they get their commission. The deal has to be done but the deal has to be as good as possible for the taxpayer.
“A good deal is followed by another good deal which allows for more good deals”. So lets get a good deal.
A good deal for the Irish taxpayer is to get an equity share that is equal to the commitment that is being made on the Irish taxpayers behalf.
@Eoin: Honestly these are senior bonds. Even if they are not covered explicitly by the government guarantee implicitly they are because sure wouldn’t the sky fall on top of us if we allowed the banks to default on senior bonds. So they are a bit like Agency bonds in the US. Guarantee is not explicit but implicit.
Regarding NAMA, I see your point about ad hominem attacks but to be fair you have not shown how this bit of “good news” is a consequence of NAMA. Evidence please and not “post hoc ergo propter hoc”.
This cartoon eloquently summarizes my feelings about this crisis:
listen, thats a reasonable objective and suggestion to have. But i just think its one laced with hugely dangerous execution risks. The biggest general anti-NAMA alternative that has been put forth has been the “apply loan losses, wipe out capital, declare insolvent, nationalise, attempt to make some bond holders take a bit, re-capitalise, re-launch, re-privatise” process, so thats the one i’m going to deal with.
I don’t believe that you can nationalise an entire banking industry en masse and just presume that credit/funding lines will remain in place as is at the same nominal size and cost. I also don’t believe that you can just assume that private capital will soon start flowing in from private investors when you’re doing your darndest to wipe out existing private capital investors via insolvency at the same time. Further, i don’t believe that if you sack en masse the senior management of these banks overnight (as suggested by many) that you’ll be left with a business-as-is situation in terms of credit availability to customers. These are the issues i have with this plan, and i think the assumptions which underly its success are based on pure theory and zero practicality.
Do i have a problem with a large govt shareholding in the banks? No, but i think its important that we try and source private capital first as i think it’ll be more difficult to source if the govt has already taken a 60%+ stake. Do i have anything against a long term bank levy being used to re-coup taxpayer losses? Absolutely not, in fact im very much in favour of it. Do i think that the govt/regulator should have a far greater say in the general running of the banks? 100% yes. However, i think that if you want to have a healthy private sector banking system going forward, you have to at least try all thats reasonably possible to keep the existing one alive in the first place. Tearing it all down in the hopes of building it all back up makes for a great taxpayer suggestion, but i’m just very worried it won’t work in practise.
if their senior debt was always going to be implicitly guaranteed by the State, why didn’t they issue any outside of the guarantee over the last 15mths+? Your answer to this question answers your own second question. Not sure what the Latin is for “you don’t need to be a rocket scientist….”
Within the eurozone, variations on government bond yields have narrowed impressively. One reason was that politicians made clear the monetary union would not be allowed to fall apart. The architects of the scheme had written a “no bail-out” clause into European Union treaties, which prevents collective liability for debts incurred by a member. But in February, Peer Steinbrück, Germany’s finance minister, broke the taboo by admitting that in the worst case “we would have to take action”.
“There is now an implicit bail-out clause,” says Sebastian Dullein, economics professor at Berlin’s university of applied science. “Countries, it seems, can also be too big to fail.” Hardline policymakers will worry about the long-run implications – the risk is that such assurances encourage irresponsible fiscal behaviour. But in the short term, the move highlighted the hidden political forces that bind continental Europe’s economies.
Eurozone political leaders showed unexpected unity in other ways. They agreed quickly not to allow any Lehman Brothers-style bank collapses….
btw, to clarify one of my comments, AIB has actually issued 1bn in 3yr bonds outside of the guarantee, @ L+250, not 3bn as i stated (c.3bn was the order book, but they decided to only issue 1bn. Assume they’ll look to do more in either a longer maturity or tighter pricing at another date).
To get back to the topic of the thread, I find it extraordinary that an article such as this one could make an argument against nationalisation that is so clearly false. And even more extraordinary that yet again it is Karl, who has a full time job to attend to, rather than a professional journalist, who points this out.
agreed. I’m pro-NAMA and this sort of thing upsets me, especially from someone like Euan King. A couple of times over the last few months i’ve thought to myself, “can nationalised banks access the ECB in the same way as private banks?”, and almost immediately i’ve remembered all the German banks that are state owned and that must have interactions with the ECB. As far as im aware, the only requirement to use the ECB discount window is to be a credit institution that maintains a ‘minimum reserve ratio’ with one of the National Central Banks in the Euro system, and this is available to both public and privately owned banks.
I wonder if the debate between nationalised/private banks is an issue of pricing. The ECB have consistently said there is no problem with nationalised banks buying government debt providing it is at market rates. I presume nationalised banks would come under greater scrutiny to follow private bank rates. Private banks, on the other hand, are presumed to be operating in the interests of their shareholders and so naturally bidding up the yield to the highest they can get.
It puts the AIB issue in an interesting light. They got away 1 bn of 3 bn ordered. The yield at swaps + 250 bp is on the 1 bn. What would it have looked like on 1.5 bn or the full 3 bn?
Some of us suspect that the primary dealers are setting ‘happy’ yields on Irish government debt. This happy arrangement might have to stop if they were nationalised (i.e. they would have to follow private primary dealers).
But it is just a suspicion…
An implicit guarantee is a necessary but not sufficient condition for the banks to issue debt.
Regarding the Latin, just google it.
I think the uncertainty here is about the following sentence from the ECB’s The Implementation of Monetary Policy in the Euro Area (p39):
“Irrespective of the fact that a marketable or non- marketable asset fulﬁls all eligibility criteria, a counterparty may not submit as collateral any asset issued or guaranteed by itself or by any other entity with which it has close links.”
This casts a doubt on whether a state-owned bank in Ireland can use Irish sovereign debt as collateral at the ECB, to the extent that the state-owned bank and the state have ‘close links’ – the existence of the state guarantee on the liabilities of banks may be interpreted as establishing such a close link.
“An implicit guarantee is a necessary but not sufficient condition for the banks to issue debt.”
Huh? So they need an implicit guarantee, plus something else? Then how’d they issue debt today?? What exactly has changed between now and the last year or so? Oh wait, NAMA…
@ future taxpayer
hmmm. Government bonds are guaranteed by the government (obviously), so a government owned bank couldnt use this as collateral? Interesting! Karl et al? So nationalised banks CAN access the repo window, but they cant do this using their own governments bonds???
The close links question is a good one. It could, of course, taken to a logical extreme, also rule out the NAMA plan. Clearly, the Irish banks have “close links” with the government—preference shares and a liability guarantee—and these links may get closer if government common equity is purchased after the NAMA transfers.
The only thing that I have heard about this is the following from a European Commission spokesman:
A commission official confirmed that, in its view nationalised banks could continue to subscribe for Irish bonds as long as they were not buying them on any kind of preferential terms.
It has been suggested that if the government nationalised the banks the state would lose them as potential subscribers for Irish sovereign debt. The commission spokesman has also said it would take a neutral stance on the ECB exchanging Irish Nama-type bonds with Irish banks if they were nationalised.
A commission official at the Economic and Financial Affairs Council (Ecofin) confirmed that ‘‘the commission would have no difficulty with the use of the securities in ECB monetary operations, irrespective of whether the bank concerned is in private or public ownership’’.
Link here http://www.sbpost.ie/post/pages/p/story.aspx-qqqt=MARKETS-qqqm=nav-qqqid=43966-qqqx=1.asp
I’m guessing this guy wasn’t talking out of his hat so, for now, I’m taking it that this isn’t an issue. If anyone has evidence to the contrary, please bring it on.
(Note that, either way, this issue is a sort of technicality unrelated to the general prohibition of monetary financing of government raised by Kelly and King, and others.)
“Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the ECB as private credit institutions”
I think it is clear that private institutions will shortly stop being eligible for emergency liquidity of the type Anglo was given.
I know nobody’s reading this anymore but just for the record, I think the most relevant responds to futuretaxpayer’s comment comes from reading two paragraphs below the paragraph cited:
“The above provision on close links does not apply to: (a) close links between the counterparty and the public authorities of EEA countries or in the case where a debt instrument is guaranteed by a public sector entity which has the right to levy taxes;”
That seems to settle that issue pretty definitively.
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