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Should we all be like the ECB?

26 June 2018
Richard Kemmish

The ECB has always been very supportive of covered bonds. Should other central banks follow its example?

I’ve always assumed that the European Central Bank’s attitude towards covered bonds was the norm and that it was only a matter of time before other central banks from the Federal Reserve to the Bank of Japan converged on the ‘correct’ treatment for covered bonds. If I’d thought about it – not sure that I ever did – I would have said that was because most covered bonds are denominated in euros and the national banks in the eurosystem – largely, but not entirely the Bundesbank – are so knowledgeable about the topic. As covered bonds grow in other currencies, so will the central bank’s knowledge of and acceptance of the asset class.

This of course conveniently ignores the Swedish and Danish central banks, both of whom have vast experience of very large covered bond markets in their own currency. The fact that their treatment of the asset class is less friendly than that of the ECB starts to undermine my assumption.

The more I speak to non eurozone central banks (I’ve been doing a lot of that recently), the more I realise that the ECB’s treatment of the asset class isn’t necessarily held up as an ideal to aspire to. Several central banks have very real concerns about the asset class both from the perspective of their own risk mitigation and from that of financial stability.

Where and when non-Euro zone central banks follow the ECB’s example? It depends. There are several ways in which a central bank interacts with covered bonds.

Easiest to dismiss is quantative easing. This doesn’t help the covered bond market. Please stop distorting the market by buying all of these covered bonds (yes, Magyar Nemzeti, I understand why but…).

More complex is the acceptance of covered bonds as collateral for day to day monetary operations at a favourable rate. Again an area where the ECB leads the field. As one central European central bank – that doesn’t accept covered bonds as collateral told me, when you have a structural liquidity surplus in your system there isn’t a whole lot of point in expanding the list of eligible collateral, particularly when covered bonds aren’t particularly liquid in that currency – liquidity being the single most important factor for collateral.

If a covered bond isn’t eligible for repo, can it really justify being eligible for bank liquidity buffers? To two are quite correlated. I’ll come back to that one in a subsequent post.

More important though, is whether covered bonds are eligible collateral for emergency liquidity support. We have seen the ECB relax their rules for covered bond collateral in Greece. If you are going to provide emergency liquidity you might as well do it against the best collateral you can get.

The ECB is the most knowledgeable central bank when it comes to covered bonds. But it is not like other central banks. It has vastly more experience of dealing with a crisis in the banking system and more understanding of covered bonds. That doesn’t necessarily mean it should be an ideal to aspire to.


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