Monday, April 29, 2013

ECB Revenue in the Case of a Low Risk Balance Sheet

In order to assess the ECB's ability to replenish capital in the event of a large loss, we estimate the ECB's low risk revenue going forward. This measure excludes interest income from the purchase of sovereigns, but also the potential losses from those purchases. The result is expressed in terms of a function of the MRO rate (the policy rate).

The low risk income consists of:
  • The MRO rate applied to 8% of the Eurosystem's outstanding banknotes (73 billion* at the end of 2012).
  • Interest income on its all-in equity of €39bn; this includes capital and reserves, provisions and the revaluation account, at the MRO rate.
  • Interest on foreign exchange reserves minus remuneration of the NCBs at .85% of the MRO rate for those reserves. This totals about zero. (The ECB lost around 100 million on this in 2012.)
The low risk revenue of the ECB is €113 billion x MRO rate.
This is about €.85 billion at the current MRO rate.

TARGET2 Income
There is net income of zero to the ECB on its offsetting TARGET2 assets and liabilities to NCBs, except in the case of a TARGET2 loss to the ECB (e.g., from a country departure and repudiation). (The ECB does report an imbalance in its TARGET2 assets and liabilities that is derived from fx swap transactions, but these transactions are matched  and should earn the ECB no income; see note 6.2 in the annual accounts, link below.)

Wednesday, April 17, 2013

TARGET2 Loss Sharing - Applicable Treaty Provisions

A TARGET2 loss to the ECB might occur with the departure of a Eurosystem member accompanied by an expectation of less than full recovery of the TARGET2 liability.   

A loss recognized by the ECB would first be offset against the ECB's capital, reserves, provisions and perhaps the revaluation account.  Recognition of a large loss, such as might have resulted from a departure of the Bank of Greece from the Eurosystem, could leave the ECB with negative equity.   

ECB losses can be shared by the NCBs under Article 33.2 of the statute, pursuant to a Governing Council vote, in an amount up to the Eurosystem's monetary income for the year of the loss.   (It isn't clear whether the ECB can recognize parts of the loss each year in order to expand NCB loss sharing beyond the "relevant year" specified in the treaty.)

If the ECB has negative equity after an Article 33.2 vote to share losses, an addition to ECB capital might be considered.   Under Article 28.1 of the statute, a capital increase requires votes by the ECB's Governing Council and the 27 finance ministers of the EU, sitting as Ecofin.   The ECB vote requires a qualified majority: two thirds, capital key-weighted and half of the shareholders (Article 10.3).  Assent of Ecofin also requires a qualified majority.  Under simplifying assumptions, until March 31, 2017, a qualified majority for a proposal by the European Commission would require at least half of the countries, with 75% of weighted votes and 62% of population.   In contrast, a recommendation from the ECB would require two thirds rather than half of the countries (TEU, Provisions Concerning the Qualified Majority, Article 3).   Starting April 1, 2017, the Ecofin vote will require 55% of the countries with 65% of the population if proposed by the European Commission, and 72% if proposed by the ECB (TFEU, Article 238).

In the event of a Eurosystem dissolution, since no obligation to share TARGET2 losses among NCBs precedes the dissolution, there is no claim to make after dissolution.   Rather, TARGET2 is just a claim against the ECB.  As a result, in the event of a dissolution, TARGET2 claims are shared among NCBs only to the extent those losses could be offset against paid-in ECB capital.

Article 32.4
It has been argued by the Austrian Central Bank, Buiter/Rahbari and perhaps others that since TARGET2 liabilities resulted from monetary policy operations, they should be shared under Article 32.4.  This wouldn't be true for:
- ELA amounts, which can be large for a departing NCB.
- In the case of an exit, where the NCB's losses result from redenomination of its TARGET2 liability rather than from losses on collateral resulting from loans to failed banks.   A country might be exiting in part to preserve the viability of its banks in which case there wouldn't be 32.4 eligible losses.
- In addition, using 32.4, which pertains to member NCBs, to compensate for losses at a non-member NCB would be open to legal challenge.