Spike in overnight ECB lending explained by bank deposit auction

ANALYSIS:Short-term funding was needed to pave the way for a quick sale of Anglo and Nationwide deposits

SUCH IS the fragile state of the European banking system that any sudden jump in emergency borrowings from the European Central Bank, particularly high-cost overnight loans, is akin to throwing a grenade into a pond.

Overnight loans from the so-called “marginal lending facility” at the Frankfurt-based bank surged by €15 billion to more than €16 billion on Thursday – the highest level since June 2009 – and remained at that level yesterday.

This led to a frenzy of speculation across financial markets that one or more banks in the euro zone were in trouble; that a bank had not borrowed enough for a week; or, more bizarrely, that the increase was due to a human error.

Banks normally turn to the ECB for overnight loans when they cannot get enough funding in the markets until they can borrow a longer-term loan under Frankfurt’s weekly facility.

Traders suggested the ECB might be squeezing debt-strained EU countries to take stronger action on their banks by refusing to sanction emergency lending assistance (ELA) through a domestic central bank.

There was some speculation that the increase may be due to changes at the Irish banks. This wasn’t surprising as the ECB is propping up the Irish banking system. At the end of last month it had loans of €126 billion outstanding to banks in Ireland and approved a further €51 billion provided by the Central Bank in emergency lending assistance.

The Government’s auction of about €14 billion in deposits from Anglo Irish Bank and Irish Nationwide Building Society was the real reason for the increase in overnight borrowing from Frankfurt. As part of the closure and gradual wind-down of Ireland’s two worst lenders, the Government announced earlier this month that it would auction their deposits and “corresponding assets” over the coming weeks.

The “corresponding assets” is the reason why the ECB overnight lending facility was tapped so heavily by Anglo and Nationwide over the past two days.

The Government is selling bonds, State-backed IOUs, issued by the National Asset Management Agency as the corresponding assets to the deposits. (Deposits are a liability on a bank’s books and cannot be sold unless they are matched with a corresponding asset.)

The Nama bonds have been used as collateral to borrow at the ECB’s normal lending facility – its “main refinancing operation”, which lends for a minimum of a week. Last week Anglo and Irish Nationwide could only use them as collateral for, at most, overnight loans as they have to be ready to be sold within weeks and possibly days.

To pave the way for a quick sale of the Nama bonds with the deposits, the two lenders can therefore only borrow such large sums of money from the ECB on an overnight basis.

The net ECB borrowings of both institutions remains the same. The two lenders are in effect just swapping their loans onto a shorter term to facilitate the sale of the Nama bonds.

Anglo has more than €12 billion of Nama bonds which are eligible ECB collateral, while Nationwide has more than €3 billion. The bonds were issued as payment for property loans transferred to the agency at sharp discounts.

Whoever buys the deposits – likely to be one or more of the four other guaranteed Irish banks – will then decide what to do with Nama bonds. Given the cost, they are unlikely to use them to borrow overnight from the ECB.

The level of overnight ECB borrowings is likely to remain at about €16 billion over the coming weeks, or at least until the auction has been completed.

A spokesman for Anglo said that the bank didn’t comment on “market and financial operations”. Nationwide had no comment. The Central Bank said it could not comment, as it was a matter for the ECB. Frankfurt does not comment on individual banks borrowing from Frankfurt.