>Is The Eurozone At Risk of Turning Into The Rouble Zone?

On February 9, 2012, the ECB’s Governing Council (GC) approved, for seven national central banks (NCBs) (of Ireland, Spain, France, Italy, Cyprus, Austria and Portugal) “… specific national eligibility criteria and risk control measures for the temporary acceptance of additional credit claims as collateral in Eurosystem credit operations”.3 NCBs can choose the eligibility criteria freely, subject to minimum requirements set by the ECB GC.


We consider this to be a dangerous and potentially disastrous decision. Either, this decision could plausibly imply a loss of central control over the Euro Area’s Monetary, Credit and Liquidity (MCL) policy. The amounts of ECB credit and liquidity provided are demand-determined once the eligibility criteria for collateral are set. Delegating the setting of these criteria to the NCBs therefore opens up the possibility of uncontrolled, and therefore accelerated, balance sheet growth for the Eurosystem, if the NCBs in the soft euro area (EA) member states are not restrained by the absence of Eurosystem-wide loss sharing associated with the new, more relaxed national collateral standards. Such a failure to respond ‘responsibly’ to the ‘you break it, you own it’ loss sharing arrangements for the new NCB collateral regimes may be individually rational if both the NCB in question and the sovereign backing it are close to insolvency.


Alternatively, if the absence of a Eurosystem-wide loss pooling regime is recognized (and enforced), the 17 Eurosystem NCBs could become counterparties with very different degrees of default risk. Normally, central bank solvency would not be threatened by increased exposure to high-risk assets, as long as that central bank’s liabilities are denominated in domestic currency — as is the case for the EA NCBs. A central bank’s ability to issue monetary liabilities (to use current seigniorage) or its capacity to borrow by issuing non-monetary liabilities (effectively secured against its future ability to issue seigniorage) should permit it to meet any payment obligations. This is not the case, however, if the ECB GC does succeed in putting a cap on the ability of the national NCBs to increase their balance sheet size despite the widening of the collateral eligibility, and if that cap is tight enough to prevent an individual NCB from saving itself from default through the use of seigniorage, but not tight enough to stop it from getting into trouble in the first place. Such a combination of a loosening of some NCBs’ collateral standards, the absence of loss pooling and effective constraints on these NCBs’ ability to use seigniorage would pose a different danger from that of ‘Roublezoneification’: it implies further differentiation between NCBs and their counterparties along national lines and the segmentation of the Eurosystem into NCBs characterized by possibly significant differences in default risk.


The decision of February 9 introduces a relaxation of collateral requirements in only part of the EA — the ‘soft’ part, consisting of 5 of the 6 EA periphery countries (only Greece is missing) and 2 of the 3 ‘soft core’ EA member states (only Belgium is missing). This selective relaxation creates an uneven playing field for central banks and their counterparties that could easily be destabilizing. And it could further accelerate the bifurcation of the EA into a soft EA and a hard EA.


If it is indeed true that there will be no loss pooling for these additional credit claims (as ECB President Draghi suggested in the Q&A of the press conference, although no formal decision of the ECB’s Governing Council to that effect has been communicated), the solvency of the NCBs in fiscally weak EA countries would be called into question even more. And counterparties in the euro area and elsewhere would start to differentiate more strongly between different Eurosystem NCBs. That would be a further nail in the coffin of a single money, credit and liquidity policy (MCL policy) for the EA and a further step towards the re-emergence of national MCL policies and, eventually, national currencies.


To read the full report: EUROZONE
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