ECB changes collateral rules in effort to shield bank funding

The European Central Bank’s governing council decided on April 22 to accept instruments that fall below its minimum credit quality requirements as collateral for its refinancing operations. 

Marketable assets and issuers of these instruments falling below BBB – which was the previous minimum requirement – will now be accepted as collateral by the ECB. One observer welcomed the move as a bold effort to preserve eurozone banks’ access to finance, but said it was not the most radical step the bank could have taken.

The ECB said the move aims to “mitigate the effect on collateral availability of possible rating downgrades” caused by the economic effects of the coronavirus pandemic. The ruling will hold until September 2021.

“It’s another welcome step, as it will preserve the collateral pool for the next 18 months, including in upcoming weekly LTRO and quarterly TLTRO operations, but it falls short of the most radical measures that the ECB could ultimately contemplate,” says Frederik Ducrozet, strategist with Pictet Wealth Management in Switzerland.

These changes affect only collateral eligibility, but not the bank’s asset purchases. For instance, it does not allow the ECB to buy high-yield corporate debt unless the governing council approves changing eligibility criteria of the corporate sector purchase programme.

“Similarly, if Italy were to lose its investment grade rating from all four agencies – S&P, Moody’s, Fitch, DBRS – our understanding is that the country’s debt should no longer be eligible to asset purchases under the asset purchase programme or the pandemic emergency purchase programme,” says Ducrozet.

The ECB governing council says it wants to ensure credit downgrades do not damage liquidity provision across the eurozone over the next year. “Together these measures aim to ensure that banks have sufficient assets that they can mobilise as collateral with the Eurosystem to participate in the liquidity-providing operations and to continue providing funding to the euro area economy,” says the ECB.

“This complements our liquidity-providing measures – including our targeted and non-targeted longer-term refinancing operations (TLTRO-III and LTRO) – by increasing the amount of collateral available to our counterparties,” write ECB vice-president Luis de Guindos and executive board member Isabel Schnabel, in an explanatory text published on the central bank’s website.

This latest decision follows the ECB’s easing of collateral standards, unveiled on April 7. In that move, the ECB announced a reduction in the haircuts it imposes on the value of collateral posted by banks accessing its long-term and targeted long-term refinancing operations (LTRO and TLTRO).

The ECB’s April 7 statement also announced it would accept state-guaranteed loans within the assets banks can submit to access liquidity through ECB facilities.

The third round of the targeted long-term refinancing operations (TLTRO III) offers banks loans at the deposit rate -0.5% for them to channel credit to businesses and households. So far in TLTRO III auctions, eurozone financial institutions have taken €867 billion.

LTRO, which was unveiled on March 12 to respond to the Covid-19 crisis, gives banks access to loans at -0.75%, below the deposit rate. So far banks have borrowed €233 billion from this facility.

“In short, today’s decision is not a game-changer as the ECB won’t be buying high-yield debt outright, nor will it protect Italy from rating downgrades completely,” says Ducrozet. “Still, it provides a backstop for the market not to be concerned about bank funding issues related to a shrinking collateral pool in case of rating downgrades.”