Category Archives: Central Bank

19/6/16: Irish Regulators: Betrayed or Betrayers?..

As I have noted here few weeks ago, Irish Financial Regulator, Central Bank of Ireland and other relevant players had full access to information regarding all contraventions by the Irish banks prior to the Global Financial Crisis. I testified on this matter in a court case in Ireland earlier this year.

Now, belatedly, years after the events took place, Irish media is waking up to the fact that our regulatory authorities have actively participated in creating the conditions that led to the crisis and that have cost lives of people, losses of pensions, savings, homes, health, marriages and so on. And yet, as ever, these regulators and supervisors of the Irish financial system:

  1. Remain outside the force of law and beyond the reach of civil lawsuits and damages awards; and
  2. Continue to present themselves as competent and able enforcers of regulation capable of preventing and rectifying any future banking crises.
You can read about the latest Irish media 'discoveries' - known previously to all who bothered to look into the system functioning:

And should you think anything has changed, why here is the so-called 'independent' and 'reformed' Irish Regulator - the Central Bank of Ireland - being silenced by the state organization, the Department of Finance, that is supposed to have no say (except in a consulting role) on regulation of the Irish Financial Services:

Please, note: the hedge funds, vulture funds, private equity firms and other shadow banking institutions today constitute a larger share of the financial services markets than traditional banks and lenders.  

Yep. Reforms, new values, vigilance, commitments... we all know they are real, meaningful and... ah, what the hell... it'll be Grand.

26/12/15: Depositors Insurance or Depositors Rip-off?

What's wrong with this picture?

In simple terms, nothing. The Central Bank has embarked on building up reserves to fund any future pay-outs on deposits guarantee.

In real terms, a lot.

Central Bank deposits guarantee will be funded from bank levies. However, in current market environment of low competition between the banks in the Irish market, these payments will be passed onto depositors and customers. Hence, depositors and customers will be funding the insurance fund.

Which sounds just fine, except when one considers a pesky little problem: under the laws, and contrary to all the claims as per reforms of the EU banking systems, depositors remain treated pari passu (on equal footing) with bondholders (see note here on EU's problems with doing away with pari passu clause even in a very limited setting: Now, let's consider the following case: bank A goes into liquidation. Depositors are paid 100 cents on the euro using the new scheme and bondholders are paid 100 cents on the euro using the old pari passu clause.

Consider two balancesheets: one for depositor holding EUR100 in a deposit account in an average Irish bank over 5 years, and one for the bondholder lending the same average bank EUR100 for 5 years.

Note: updated version

Yes, the numbers are approximate, but you get the point: under insurance scheme the Central Bank is embarking on, the depositor and the bondholder assume same risks (via pari passu clause), but:

  • Depositor is liable for tax, fees and insurance contributions, whilst facing low interest rates on their deposits; while
  • Bondholder is liable for none of the above costs, whilst collecting higher returns on their bonds.

So, same risk, different (vastly different) returns. Still think that insurance fund we are about to pay for a fair deal?..

8/8/15: Transactions Costs v Quality of Banks’ Collateral

In standard financial theory (and practice), presence of transactions costs has an impact on asset prices traded in the markets. A recent ECB Working Paper, titled "Collateral damage? micro-simulation of transaction cost shocks on the value of central bank collateral", by Rudolf Alvise Lennkh and Florian Walch (ECB Working Paper Series, No 1793 / May 2015: "analyses how changes in transaction costs may affect the value of assets that banks use to collateralise borrowings in monetary policy operations."

The authors estimate the effect of a 10 basis point increase in transaction costs to be a decline of -0.30% in collateral value. Adjusting for the expected drop in the volume of trades for each asset (reduced liquidity), the decline in asset prices is shallower - at -0.07%. "We conclude that banks will on average suffer small collateral losses while selected institutions could face a considerably larger collateral decrease."

So far - benign?

The problem, of course, is in that second order effect. The authors look at 25% and 75% decreases in turnover of pledged collateral debt instruments (e.g. bonds pledged by the banks in repo operations). This second order effect reduces the loss of collateral value to -0.22% and -0.07%, for the two assumed turnover reductions scenarios, respectively. In other words, the lower the turnover rate of the pledged assets, the lesser is the impact of the transactions costs on collateral value.

Now, as the study notes, when collateral is held longer (turnover lower), liquidity in the markets is impacted. The longer the banks hold collateral assets off the markets and in the central banks' repo vaults, the lesser is market liquidity for traded collateral-eligible paper. Thus, the higher is the associated liquidity risk. Banks dump risk premium into the markets.

Cautiously, the ECB paper goes on: "The results underline that transaction costs in financial markets can be one among many factors contributing to the scarcity or decline of liquid, high quality collateral. …an upward transaction cost shock that occurs simultaneously with a market or regulation-induced shortage in collateral assets, and in particular high-quality collateral assets, could hamper the access of financial institutions to central bank liquidity. The central bank could [make] additional collateral eligible for monetary policy operations. As most of high-grade collateral is already central bank eligible, such a move could entail a shift to collateral assets with more inherent risk that would have to be compensated with appropriate haircuts. This in turn could increase asset encumbrance on banks’ balance sheets."

But there is another channel not considered in the paper: reduced turnover of collateral implies reduced supply of assets into securitisation pools, as well as into the OTC markets. Both effects are hard to estimate, but are likely to induce even higher risk premium into the markets for risky assets, pushing the above estimates of costs wider.

As an interesting aside, the table below summarises, by the end of 1Q 2014, one quarter of all collateral pledged into Eurosystem central banks repo operations was of low quality variety Non-marketable assets (in other words, assets with no immediate markets). This represents an increase in the share of low quality assets from 24.75% in 1Q 2012 to 24.96% in 1Q 2014. Medium-to-low quality stuff accounted for another 20 percent of the total.

Now, for all the esoteric debates about the ECB supplying liquidity, not providing solvency supports, one wonders just how much of a haircut would all of this proverbial 'assetage' gather were it to be collateralised into the markets to raise the said liquidity… for you know: if a bank is solvent, its assets would cover its liabilities, inclusive of haircuts, which means they are repoable… in which case, of course, there is no liquidity shortage to cover, unless markets were misfiring. The latter simply can't be the case in 2014 when the financial markets were hardly oversold.