Thursday, March 21, 2013

Loss Sharing in the Eurosystem - Excluding Target2 Losses

Monetary Policy Operations Loss Sharing Among NCBs

Monetary policy operation losses are not automatically shared among Eurosystem NCBs.  They are shared only pursuant to an ECB Governing Council vote, which need not be pro-forma.

The Governing Council may decide that national central banks shall be indemnified against costs incurred in connection with the issue of banknotes or in exceptional circumstances for specific losses arising from monetary policy operations undertaken for the ESCB. Indemnification shall be in a form deemed appropriate in the judgment of the Governing Council; these amounts may be offset against the national central banks' monetary income.
Despite the plain language that a vote is required, Eurosystem official publications claim that this loss sharing is automatic:  

Dutch National Bank 2011 Annual Report:
The risks, and thus the potential losses, stemming from OMO and SMP are shared within the Eurosystem.
ECB Annual Report 2011: 
The residual risk that may emerge despite risk mitigation measures is, as a rule, shared among the euro area NCBs in accordance with their respective shares in the ECB’s capital...
As do commentators:

Losses and profits made by the ECB and the NCBs in the implementation of the common MCL policy are shared among the NCBs in proportion to their share in the ECB capital.
The losses incurred by the Eurosystem are to be shared by all national central banks in proportion to their shares in the ECB's capital.
The official legal statute governing the Eurosystem is quite vague about the implications for an NCB of losses incurred in monetary operations… In practice, the Governing Council of the ECB used the defaults by Lehmans and other banks in 2008 to clarify in a statement in March 2009 that losses should be shared in full by the Eurosystem NCBs in proportion to their ECB capital key shares.

Rather than contemplate a pro-forma vote, the statute prescribes a high hurdle to loss sharing by saying that the Governing Council may indemnify in "exceptional circumstances for specific losses".   While it might be argued that the treaty means "in the exceptional circumstances of specific losses", that is not what it says.  The French, German and Spanish versions of the treaty are consistent with the view we articulate.   In addition, we have not noticed other language in this treaty that is gratuitously descriptive.

There is one known loss sharing vote by the Governing Council.  In explaining the event,  rather than describing a pro-forma vote, they appear to be providing a required justification.   They comment elaborately on the Bundesbank's compliance with rules and procedures regarding the losing transactions:

From the 2009 ECB press release [emphasis added]:

The Governing Council has confirmed that the monetary policy operations in question were carried out by these NCBs in full compliance with the Eurosystem’s rules and procedures, and that these NCBs had taken all the necessary precautions, in full consultation with the ECB and the other NCBs, to maximise the recovery of funds from the collateral held.   
The counterparties in question submitted eligible collateral in compliance with the Eurosystem’s rules and procedures.
As we aren't aware of any general concern regarding Bundesbank procedural compliance, we think the Governing Council is meeting some requirement.   Some commentators see a clarification in the press release that losses will be shared in the future (see Whelan, above).  But as only a one-time indemnification is described by the ECB, this view is surprising.

The Bundesbank recognizes that a vote is required but describes loss sharing as customary.  Bundesbank 2011 Annual Report:

These losses are customarily borne jointly, dependent on a decision of the ECB Governing Council, by the partner central banks in line with their capital share in the ECB.
As we are aware of only one loss sharing incident, it isn't clear how fully rooted the custom is.

ECB Loss Sharing with the NCB Members of the Eurosystem

In the event of a loss incurred by the ECB, the shortfall may be offset against the general reserve fund of the ECB and, if necessary, following a decision by the Governing Council, against the monetary income of the relevant financial year in proportion and up to the amounts allocated to the national central banks in accordance with Article 32.5.
ECB losses are shared only pursuant to a Governing Council vote and only to the extent of the relevant year's monetary income.   Sources of ECB losses include foreign exchange reserves changes, SMP and TARGET2.  Last year the Eurosystem’s monetary income was roughly €27 billion and the ECB's capital and reserves was €38.8 bn.  The ECB's TARGET2 exposure to Greece is €87 bn (as of January 2013) and to Spain is €297 bn (as of February).

*Unlike Article 33.2,  Article 34.2 can be amended by the European Parliament and the Council (TFEU 129).

1 comment:

  1. The various forms of income suppression may be a relevant consideration - provisions for general losses and the revaluation account for securities that have been marked higher. These two account for 12% of total assets at end-2013 (22% isolating intra-Eurosystem claims and other financial assets).