Panellists at today's (June 20) Central Banking ON AIR event said the European Central Bank had "averted a disaster" by accepting a wider range of collateral, and praised Bank of England efforts to follow the ECB's lead.
Patricia Jackson, lead partner for Ernst & Young's Europe, Middle East and Africa Prudential Practice, Bill Allen, a visiting senior fellow at the Cass Business School and David Beatrix, deputy head of Collateral Management Services at BNP Paribas, joined Chris Jeffery, editor of Central Banking Publications, in a discussion of developments in the use of collateral in financial markets.
Jackson and Allen both praised the ECB's diversification of eligible collateral. "The ECB has been a hugely important safety valve, for the UK as well," said Jackson. The Bank of England is now "catching up", Allen said, following its announcement on June 14 of a monthly extended collateral term repo, with the first auction taking place today.
Beatrix warned, however, that eligibility can only be extended so far, or risk pricing becomes problematic. "The more eligibility is opened up, the more there is a risk of adverse side effects," he said. Allen agreed this could be a problem for central banks in particular that are not used to pricing a wide range of assets. "Central banks would effectively have to provide public credit ratings for individual bonds," he said.
Despite this problem, Allen and Jackson agreed diversification was necessary. "The sovereign debt crisis has raised huge questions about relying on one type of asset," Jackson said. Strong demand for safe assets has created a "captive market", with institutions all chasing the same assets, she said.
The panellists emphasised, however, that diversification of collateral should be more measured in "non-crisis" times. The ECB has taken on large quantities of mortgages as collateral, "but these are not a liquid asset and would not have been taken on in normal times," Allen said. The central bank should eventually "wind down" this exposure, he said. Beatrix agreed the exposure was dangerous. "It is hard to tell whether there is sufficient liquidity," he said.
"It is a very good idea in non-crisis times to use eligibility policy to give banks the incentive to load up on safe assets," Allen said. "Authorities can do far more than the industry can do itself," Jackson added.
Beatrix raised concerns that the provision of high-quality assets still had to cope with the new regulatory environment under Basel III. “For commercial banks, this causes the costs of capital to increase, and this is charged to end-users,” he said.
The panellists agreed there were significant challenges facing central banks in the future. Jackson praised the ECB's long-term refinancing operation, but said "the issue is the longer-term solution”, once the three-year term is up. Markets and regulators are being more cautious, and "this creates a collective squeeze", Allen said, adding "the situation looking forwards is not comfortable".