The ECB Vs the BoE

It’s interesting that in recent years whilst the European Central Bank (ECB) has provided almost unstinting support for Europe’s banks, in contrast, the Bank of England (BoE) has been less than supportive of UK banks. The issue is illustrated with the ECB’s Long Term Refinancing Operations (LTROs) in December and February, providing three-year loan facilities at a cost of 1% to any bank with Euroland activities and eligible collateral. The €1bn+ handed over is higher than the national output of the Netherlands and more than four times that of Greece.

The evidence is that Mr Draghi, ECB president since November 2011, intends to support commercial banks with central bank funding, and before the LTROs, many Euroland banks, particularly banks in peripheral economies such as Spain, Portugal and Ireland with large external debts, had experienced funding difficulties. The practical response had been to sell government bonds rather than call in loans, and the resultant falls in the value of Euroland sovereign debt undermined confidence in the single currency, accentuating concerns on the viability or sustainability of the euro.

The ECB’s LTROs led to the stopping of sales of government bonds by the banks, and has allowed spreads to fall back, at least deferring the challenges until maturity of the LTRO arrangement in three year’s time.

Importantly, the ECB’s provision of funding has afforded troubled banks sufficient time to reorganize. For the duration of the ECB loan, banks will earn profits on their good assets, boosting solvency. In addition, banks that have been short of cash in the recent period of market turmoil now have the chance to sell loan portfolios to banks with strong deposit resources.

With the premise that the ECB has ensured that the banking system (and hence the supply of credit) are no longer at risk of shrinkage, commentators are moving to be more optimistic on the Euroland economy, with some predicting recovery later in the current year.

The ECB stance is in stark contrast to the policies of the BoE.

Looking back, we can recall that the global interbank market ceased to function normally in July and early August 2007, and on 9th August 2007 leading British banks approached the Bank of England for an easing of collateral requirements on so-called repurchase operations, more commonly referred to as repos. The BoE’s response was that there could be no change, and the Northern Rock crisis, involving the first run on a British bank for over a century, commenced about a month after the 9th August meeting.

The BoE also decided not to provide long term loan support. In Alistair Darling’s memoir Back from the Brink, he recounts a private meeting that he had with Fred Goodwin in Edinburgh during the 2007 Christmas period, and he states that in that meeting Goodwin argued that the banks’ key problem was a lack of liquidity, which could be countered by long-term central bank lending. Clearly Darling could not persuade the BoE to provide such a facility, and in evidence to the Treasury Committee of the House of Commons in September 2008, the BoE’s Mervyn King argued that it was not the responsibility of a central bank to provide long-term finance, with that task falling to either the government or the private sector.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla