Determinants of the Eurosystem's Central Banks Provisions
| DOI | http://doi.org/10.1111/sjpe.12171 |
| Author | Jens Klose |
| Date | 01 September 2018 |
| Published date | 01 September 2018 |
DETERMINANTS OF THE
EUROSYSTEM’S CENTRAL
BANKS PROVISIONS
Jens Klose*
ABSTRACT
Central bank provisions may be used as a measure of the perceived risk of the
balance sheet composition by a central bank. We identify three possible sources
that may change the size of the provisions. These are: The length of the balance
sheet, the central bank revenues, and measures of fiscal stress. Using data of the
11 founding members of the Eurosystem for the years 1999–2015, we are able to
test each of the three determinants. We find that provisions are increased with
the size of the balance sheet especially in the recent financial crisis. Moreover,
provisions are increased at the cost of lower central bank revenues. While this
holds for the pre-crisis period this relationship seems to be less pronounced in
the crisis period probably because of the more active collateral policy. Finally,
central banks do not tend to lower provisions because of fiscal tensions. This is
even more true in the crisis period.
II
NTRODUCTION
The financial crisis of 2008/2009 and the following European debt crisis have
forced the European Central Bank (ECB) to take extraordinary measures.
The ECB did so by adjusting their refinancing operations to full allotment
(ECB, 2008), increasing the period of the refinance operations to up to 4 years
(ECB, 2014), the purchase of covered bonds in three programs (ECB, 2009,
2011, 2014a), asset-backed securities (ECB, 2014a), government bonds (ECB,
2015) and corporate bonds (ECB, 2016), and the frequent lowering of collat-
eral standards needed to take part in the refinancing operations (Eberl and
Weber, 2014 or Belke, 2015) among other things.
1
Taken together these mea-
sures either increased the balance sheet of the ECB or made the associated
risk in the balance sheet more difficult to be correctly priced.
2
*THM Business School
1
See also Cour-Thimann and Winkler (2012) for the ECB’s unconventional measures up
to 2012.
2
See Creel et al., 2016 for the effects of the unconventional (as well as the conventional)
monetary policy of the ECB on interest rates and lending volumes.
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12171, Vol. 65, No. 4, September 2018
©2018 Scottish Economic Society.
328
In such a situation the central banks of the Eurosystem, as would all other
companies facing comparable circumstances, have to adjust provisions to this
altering in the perceived risk. While the refinancing operations of the ECB are
generally performed against collateral which is moreover subject to haircuts
based on the risk of the underlying asset, the newly initiated purchase pro-
grams are not subject to these haircuts. Therefore, potential losses from those
assets may be even higher. The result of higher risks should be represented in
increased provisions made. In this way the level of provisions is an indicator
of the central banks’ perceived risk associated with their balance sheet and
may be used as a crisis indicator. This holds even more since the decision to
introduce a new measure is generally made by the ECB governing council.
Therefore, some national central banks (NCBs) may judge the risk associated
with the new measures higher than the governing council does but the NCB
president, being a member of this council, was overturned by the other NCB
presidents and the ECB executive board. However, a central bank is special in
this case since it can by definition not run out of liquidity and could in princi-
ple also operate with negative equity as long as its credibility is not doubted.
But in practice central banks try to avoid such a situation even though history
has seen some episodes of certain central banks operating with negative
equity.
3
The fear of running out of equity and possibly being dependent on
fiscal recapitalization might be one reason why central banks increased their
provisions in order to guarantee their independence.
4
In the context of the
ECB, losses may occur from two sources: First, the obvious case when bonds
bought by the ECB default or banks are unable to repay their money bought
from the ECB and underlying collateral is not able to recollect the money.
Second, money in refinancing operations is currently lend for up to 4 years at
a zero or even lower interest rate. Therefore, it might be costly to change
monetary policy in these 4 years once economic conditions suggest tightening
monetary policy. This could only be done by collecting term deposits at the
liability side of the ECB balance sheet which would have (possibly substan-
tially) higher than zero interest rates in a boom phase.
Moreover, Belke and Polleit (2010) state that when losses in central bank
balance sheets are due to a deterioration in public finances, for example, by
sovereign defaults on government bonds held by the central bank, fiscal recap-
talization is no longer an option, thus possibly leading to higher inflation.
This problem may be especially serious in the Euro-Area since there is no gov-
ernment explicitly backing the ECB, whereas the national governments are
backing their NCBs.
Indeed, the ECB and the central banks forming the Eurosystem inscreased
their provisions substantially in the crisis. For example, the ECB increased
3
Several studies have investigated the issue of financial strength (i.e., negative equity) on
the central banks’ target of delivering stable prices. See, for example, Klueh and Stella
(2008), Adler et al. (2012) or Benecka et al. (2012). See also Buiter (2008) or Belke and Pol-
leit (2010) for a discussion on central bank bankruptcy and why they could not run out of
liquidity.
4
See Albinowski et al., 2014 for the determinants of trust in the ECB interest policy.
DETERMINANTS OF CENTRAL BANK PROVISIONS 329
Scottish Journal of Political Economy
©2018 Scottish Economic Society
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