The ECB has to stop propping up banks

A year into the crisis, it’s time to let banks start to fend for themselves — or at least let their shareholders do the heavy lifting. That’s what the President of the Dutch Central Bank Nout Wellink had to say earlier today. Below is my translation of an article from the Financieele Dagblad, a Dutch financial newspaper, which interviewed Wellink, a member of the ECB’s governing council.

Wellink suggests that the ECB use Walter Bagehot‘s model for a lender of last resort: lending freely at a penalty rate but limiting the overall liquidity to the banking sector as a whole. If Wellink’s views are shared by other ECB governing council members, we may need to get ready for some serious liquidity strains for weaker banks going forward. The Bank of Canada has already stepped away from its role in providing liquidity. Will the ECB be next? And what will this mean if a European bank runs into trouble?

Dutch National Bank concerned about bank’s injections

August 21, 2008, 8:00 pm | FD.nl
Prisco Battes and Ahrend Clahsen

The European Central Bank cannot continue forever to provide liquidity to banks with money market problems. So says Nout Wellink, President of the Bank of the Netherlands and board member of the ECB, in an interview with this newspaper.

“If we see that banks have become very dependent on central banks, then we must encourage them to tap other sources of funding.” This means that shareholders, in extreme cases, must come up with money.

Ever since the credit crisis erupted a year ago, central banks have pumped tens of billions into the market to avoid a systemic crisis. “There has been an adequate response,” Wellink said. “But there must be a limit to how long you can do this. There comes a point when the market takes over. “

Less liquidity

Earlier this week, the British central bank announced it was to make less liquidity available. During the crisis, the Bank of England has had a special window where banks could finance mortgages. ]That window will be closed in October.

The measure comes at a time when some banks are still heavily dependent on the central banks for their financing. Because of mutual distrust, the money market where banks lend money to each is very slippery. The rates for uncollateralised loans are extremely high. Some banks cannot borrow at all without collateral.

Rescue package

In the Netherlands, NIBC bank in The Hague has been especially heavily affected by the crisis. But, even Rabobank, with its triple-A status, has an emergency package of mortgages ready in order to borrow in Frankfurt.

According to Wellink, Central banks cannot continue to support commercial banks forever, because the economy cannot recover without a healthy banking sector. “Banks are weakened,” said Wellink. “They should strengthen their own backstops because of their central position in the economy.” According to the bank president, there is growing evidence that the crisis has not ended. “It may take some time before the economy is back on track.”

Restrict money supply

Wellink says not to fear banks failing as a result of restricting liquidity. “We will not let this happen.” The ECB cannot turn away banks that offer the right collateral if they come knocking out of liquidity concerns. However, the ECB can auction off the amount of money allocated to the sector as a whole in order to limit the supply. Moreover, the interest rates in those auctions will be fixed, will be increased.

In that way, banks are addressed directly. “If a bank lends excessively, central banks and regulators will see that,” Wellink said. “Then, of course, can follow a conversation can follow.”

Transparency

Wellink would not say whether he recommends Dutch banks get money from shareholders as soon as possible before the rest of the industry does. But he says that shocks to investors can be avoided if [banks] display openness as soon as possible. “If what will happen is transparent, then the shareholders will understand.”

Source
DNB bezorgd over injecties banken, Financieele Dagblad