- The role of the ECB in the ongoing eurozone and banking crisis has been significantly understated. In parallel with the IMF’s and EU’s multi-billion euro interventions, the ECB has engaged in its own bail-out operation, providing cheap credit to insolvent banks and propping up struggling eurozone governments, despite this being against its own rules. The ECB is ultimately underwritten by taxpayers, which means that there is a hidden – and potentially huge – cost of the eurozone crisis to taxpayers buried in the ECB’s books.
- As a result, the ECB’s balance sheet is now looking increasingly vulnerable. We estimate that the ECB has exposure to struggling eurozone economies (the so-called PIIGS) of around €444bn – an amount roughly equivalent to the GDP of Finland and Austria combined. Although not all these assets and loans are ‘bad’, many of them could result in serious losses for the ECB should the eurozone crisis continue to deteriorate. Critically, struggling banks in insolvent countries have been allowed to shift risky assets away from their own balance sheets and onto the ECB’s (all the while receiving ECB loans in return). Many of these assets are extremely difficult to value.
- Overall, the ECB is now leveraged around 23 to 24 times, with only €82bn in capital and reserves. In contrast, the Swedish central bank is leveraged just under five times, while the average hedge fund is leveraged four to five times. This means that should the ECB see its assets fall by just 4.25% in value, from booking losses on its loans or purchases of government debt, its entire capital base would be wiped out.
- Hefty losses for the ECB are no longer a remote risk, with Greece likely to default within the next few years – even if it gets a fresh bail-out package from the EU and IMF – which would also bring down the country’s banks. We estimate that the ECB has taken on around €190bn in Greek assets by propping up the Greek state and banks. Should Greece restructure half of its debt – which is needed to bring down the country’s debt to sustainable levels – the ECB is set to face losses of between €44.5bn and €65.8bn on the government bonds it has purchased and the collateral it is holding from Greek banks. This is equal to between 2.35% and 3.47% of assets, meaning it comes close to wiping out the capital base.
- A loss of this magnitude would effectively leave the ECB insolvent and in need of recapitalisation. It would then have to either start printing money to cover the losses or ask eurozone governments to send it more cash (via a capital call to national central banks). The first option would lead to inflation, which is unacceptable in Germany, while the second option amounts to another fully fledged bail-out, with taxpayers facing upfront costs (rather than loan guarantees as in the government eurozone bail-outs).
- The ECB’s actions during the financial crisis have not only weighed heavily on its balance sheet, but also its credibility. Firstly, as a paper published by the ECB last year noted, “The perceptions of a central bank’s financial strength have an impact on the credibility of the central bank and its policy”. Secondly, by financing states, the ECB has effectively engaged in fiscal policy – and therefore politics – something which electorates were told would never happen.
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Raoul Ruparel
Mats Persson
Open Europe