Monday, August 23, 2010

Economics 23/8/10: Is ECB contradiciting itself on banks stability?

Updated below

Here is a note of the day, to be followed by a question of the day:

ECB's Axel Weber (a 'hawk' in his pre-crisis life) is proposing in the FT today that the ECB should extended unlimited refinancing operations for Eurozone banks up to three months until at least early 2011.

This call, if followed upon, would
  1. make it harder for the ECB to execute any serious QE exit strategy,
  2. shows that the situation in the EU banking sector remains critical;
  3. indicates that forward looking central bankers, like Weber don't really believe that the funding markets are ready to properly price the risks of European (including, of course, German) banks, even in the short run (under 1 year);
  4. shows clearly that despite statements to the contrary, ECB governors (at least some) don;t really buy into the idea that Euro area banks will be able to unwind, absent ECB help, the €1.3 trillion in debt coming due in the next 2 years.
Now, question of the day: If the EU stress tests were anything better than a shambolic PR exercise (I don't think they were, but let's entertain the idea), why would ECB need to worry about the banking sector funding situation? After all, the tests, allegedly, have shown that Eurozone banks are well capitalized and present no systemic risk.

So either the tests were useless (in which case Weber is right in his call) or ECB has no business continuing priming the liquidity pump (in which case Weber is wrong in his call).

And a couple of hours after my question of the day note above, Bloomberg weighed in with a mighty crack at the ECB's position (here).

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