Uneasy ECB May Mull Bank-Bond Buying Amid Unappealing Menu
Europe’s bond investors are starting to ask whether the European Central Bank will pair a potential interest rate cut with unprecedented purchases of senior bank debt.
Policy makers have previously shied away from buying unsecured bank bonds, not least because of possible conflicts of interest stemming from the ECB’s role in regulating banks it would be purchasing notes from. Still, they may consider it at a policy meeting next week, particularly if they vote to further lower negative interest rates that have been squeezing lenders’ profits for years.
“It would not be ideal of course, but the ECB has already been forced to venture into pretty controversial territory with quantitative easing,” said Gilles Moec, group chief economist at Axa Investment Management, which oversees $822.7 billion of assets. “Given what is left of the ECB’s arsenal, ideal options are not on the menu.”
Buying senior bonds would be a “much more efficient way” of helping banks weather a further rate cut than potential alternatives as it would benefit lenders in weaker economies with significant upcoming issuance needs, Moec said. The change could also greatly expand the universe of notes eligible for ECB purchase as bank bonds make up about 30% of the euro high-grade universe, according to M&G Investments.
Investors are speculating about a resumption and broadening of ECB bond buying after central bank President Mario Draghi hinted at possible easing measures last month to help spur the economy. Interest-rate futures suggest an about 85% chance of a rate cut at next week’s ECB meeting or in September.
The ECB has only previously bought covered bonds from banks, which are generally backed by mortgages. It excluded unsecured bank debt from the Corporate Sector Purchase Program, which has accumulated 177.7 billion euros ($200 billion) of notes since 2016. Central bank board member Benoit Coeure said in 2016 that buying senior bank bonds would “create the wrong incentives for banks to reform”.
Another board member, Yves Mersch said in March that he didn’t think bank-bond buying “will happen any time soon under the present monetary policy regime.” His colleague Peter Praet has also previously voiced concerns about bank-bond buying, given the ECB’s regulatory role. The central bank directly supervises 114 lenders, which together hold almost 82% of banking assets in the euro area, according to its own data.
“We are convinced that senior bank debt will not be included in any future CSPP 2.0 for obvious conflict of interest reasons,” said Franck Dixmier, global head of fixed income at Allianz Global Investors. The ECB can also find plenty more corporate bonds to buy without widening its criteria, he said.
Conflict-of-interest concerns may be surmountable because the ECB’s supervisory arm is operationally ring-fenced from the monetary policy side, Axa’s Moec said. Decisions on resolving a failing bank are also already the responsibility of the Single Resolution Board, an EU agency, rather than the central bank.
Other hurdles to ECB bank-bond buying include eroding the principle that banks can only borrow against collateral, according to Commerzbank AG analysts Ted Packmohr and Michael Weigerding. Bond purchases could also undermine other ECB programs, such as the repo business, by giving lenders a new way to access to central-bank funding, they said.
Possible alternatives to bank-bond buying include ending the uniform deposit rate and switching to a tiered system that could exempt some funds from negative rates. The ECB could also indirectly pull down bank-funding costs by resuming new corporate-bond purchases. This may be more likely than buying bank bonds, even if the market impact may be limited by spreads now being much tighter than in 2016, said Puneet Sharma, head of credit strategy in investment management at Zurich Insurance Group AG.
Still, Draghi’s history of springing surprises when announcing stimulus measures may be the best reason to expect policy makers to take the leap into the bank-bond market, even with all of the challenges it would entail.
“The ECB may well surprise markets again,” M&G’s Wolfgang Bauer said in a note. “The big twist this time round could be the inclusion of senior bank bonds.”