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ECB Bond “Sterilization”, Really??

When discussing European sovereign bond purchases it is never polite to say the ECB “monetizes” when talking to “very serious people” –  after all they “sterilize”, or in other words, don’t see an actual balance sheet expansion, as they offload the entire cumulative balance (which as of this week was €194.5 billion) onto other financial institutions. In this way, the bank supposedly does not take on interest rate risk, which in a feedback loop, is the cause and event of such modestly unpleasant monetary expansion episodes as the Weimar Republic. What few discuss, however, is just where the banks get the money to actually buy bonds from the ECB. Well, as it turns out, all the money used for sterilization comes from, you guessed it, the ECB, in what is one massive several hundred billion circle jerk. In essence what the ECB does, by pretending to not monetize and pretending to sterilize, is taking on not only interest rate risk one level removed, but also bank solvency and liquidity risk! In turn, this makes the central bank even more undercapitalized in practice than it is (and at 50+ leverage, it is already pretty, pretty undercapitalized), as once the banking dominos start crumbling, it will be the ECB that is left on the hook… and thus the Fed and the US taxpayer. So perhaps while Germany is complaining every single day about the possibility of outright money printing by the ECB, it will be wise to ask itself: who is giving Europe’s insolvent banks, which just borrowed a record amount of short-term cash from the ECB to be recycled precisely into such indirect monetization, their cash?

Below is the official announcement from today on the full sterilization procedure in which €194.5 billion in sovereign bonds had to be bid up by European banks, which submitted Indications of Interest for €233 billion.


But where did the €233 billion come from? Why from the ECB of course, or specifically from its weekly Main Refinancing Operation, which saw the ECB hand out €247.2 billion to banks at a rate of 1.25%, the same as the max rate on the Tender operation above. Just enough to cover the full monetization amount, and have a little cash left for pocket money.

Euro zone banks’ demand for European Central Bank funding surged to a two-year high on Tuesday, as fast spreading sovereign debt worries left lending markets virtually frozen and the ECB the only available funding option for many institutions.

Intensifying fears about the financial health of Italy and Spain have further hurt the interbank money market over the last fortnight as banks have continued to scale down the list of peers to which they are prepared to lend.


The ECB’s weekly, limit-free handout of funding underscored the widespread problems on Tuesday with 178 banks requesting a total of 247 billion euros.


The amount was the highest since mid-2009 and well above both the 220 billion expected by traders polled by Reuters on Monday and the 230 billion taken last week.


“We don’t need to look far for signs of tension in the money markets, with the ECB acting as the main intermediary with 1) deposits parked at ECB at elevated levels and 2) MRO usage also now increasing sharply,” said IFR strategist Divyang Shah.


“The ECB is the main vehicle through which the money markets are able to make transactions, highlighting that we have not just a liquidity crisis on our hands but also heightened concerns over solvency,” he said.


The ECB has reinstated some of its most potent crisis-fighting tools over recent months in a bid to try and calm tensions again, including ultra long-term one-year liquidity injections.


So far, however, the moves have done little to revive interbank lending. Banks are now borrowing more than 500 billion euros but data shows almost two thirds of that money is being deposited back at the ECB, compared to around one third after the collapse of Lehman Brothers back in 2008.



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