The integrity of the European Central Bank's liquidity scheme is in doubt, with reports that commercially unviable bonds are being created to offload illiquid assets.
The ECB has injected liquidity into the market with financing in exchange for collateral. Doubts about the quality of this collateral have been growing for months, but the extent of the abuse is only now becoming apparent.
"Banks are creating bonds to repo with the ECB that wouldn't be sellable," said one structured finance lawyer. "All the ECB requires is that the collateral is true sale, has an EU listing, and is single-A rated. And some deposited bonds are barely scraping an A from one rating agency."
The ECB's requirements for eligible collateral are looser than those applied by the Bank of England and its Special Liquidity Scheme. It, for example, accepts assets as collateral that date from 2007 – the assumption being that these assets are only unsellable due to the credit crunch – and that are triple-A rated.
The Bank of England also values assets more harshly than the ECB, thereby discouraging use of the scheme by institutions that don't need liquidity urgently.
As a result, the ECB has become a dumping ground for the assets that other liquidity schemes will not accept as collateral. Institutions are even setting up offices in jurisdictions to enable them to access ECB funds. Nationwide announced its decision to open in Ireland in mid-August.
The ECB needs to reconsider its criteria for collateral. As one partner says: "The ECB scheme seems overly generous. They have complained that the quality of collateral has diminished, but I suspect that it's the ECB that has lost sight of the objective."