Three Ideas to Improve the International Role of the ECB - DGAP Policy Brief
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German Council on Foreign Relations No. 04 February 2021 COMMENTARY Three Ideas to Improve the International Role of the ECB The ECB has been forced – in part by cess to euro swap and repo facilities to the COVID-19 crisis – to review its bi- non-euro area central banks – thereby lateral arrangements with foreign cen- helping the ECB to stabilize prices and tral banks. But the recent changes made mitigate financial stability risks do- by the ECB fall short of the Europe- mestically and abroad. an Commission’s ambitions to boost Shahin Vallée Head, Geo-Economics the international role of the euro. We During the 2008 global financial cri- Program, DGAP suggest the ECB should put in place sis and its aftermath, the ECB had to an alternative three-pillar frame- make hard choices about its FX swap work to improve the international role policy and adopted a very conservative of the ECB and cement its pivotal role line, precisely when it was enjoying the in the international financial system. generous support of the Federal Re- serve’s own US dollar liquidity lines. In a new paper released on January 19, Indeed, between 2009 and 2011, the the European Commission (EC) reit- ECB refused to extend swap lines to erated its commitment to strengthen Hungary and Poland when they were the international role of the euro. This in a financial crisis and in need of euro Daniela Gabor is part of a long-standing plan that has liquidity, or to Latvia when the Swiss Professor of Economics and Macro-Finance, been followed by little action so far. Al- National Bank and the Swedish Riks- UWE Bristol though the report is broad, it does not bank respectively rose to the challenge mention actions to be taken by the of effectively offering support when ECB – despite the fact that its role as the ECB should have also been there to a global lender of last resort is becom- help. ing ever more important to the inter- national financial system. The new changes introduced by the ECB due to the COVID-19 pandem- Since the economic shock of the ic do not go far enough in creating the COVID-19 pandemic, the ECB has framework to provide euro liquidity to overhauled its euro liquidity provision those who may need it. The ECB’s bi- to foreign non-euro central banks. The lateral lending framework – via swaps overhaul has involved reviewing exist- and repos – continues to create double ing arrangements and extending a c - standards between EU member states
No. 04 | February 2021 2 COMMENTARY Three Ideas to Improve the International Role of the ECB THE EUROPEAN CENTRAL BANK’S FRAMEWORK OF SWAP AND REPO LINES collateral National EUR Bank of Serbia Danish Bank of Bank of National Canada Japan Bank National Bank of Bulgarian Albania National Federal S TA N D I N G Bank Repo lines Reserve G LO B A L F X S WA P L I N E ECB Swedish ECB granted under EUREP Riksbank Hungarian Swiss Croatian National Bank of National National Bank England Bank Bank ……… National Bank of Romania S WA P L I N E S REPO LINES ECB provides euro against currencies accepted ECB provides euro against adequate euro- by the ECB for swap line operations dominated collateral accepted by the ECB Source: ECB | own illustration and lacks accountability and trans- 3. A discretionary emergency assis- a corresponding Bulgarian lev loan to parency. The ECB falls short of being tance facility to provide financial assis- the ECB. These FX swaps ensure the a lender of last resort for financial sys- tance to foreign countries undergoing flow of hard currency/euro liquidity tems that are dependent on euro li- a balance of payment crisis. where and when it is needed and pre- quidity. As a result, the ECB is failing to vent financial instability from tempo- reduce financial stability risks and to rary liquidity shortages from setting in. promote the international role of the DOUBLE STANDARDS euro as much as it should. FOR EU MEMBER STATES In contrast, repos are more onerous for the borrowing central banks for a In this paper, we first review in de- In the hierarchy of instruments avail- variety of reasons. Sticking with our tail the shortcomings of the ECB’s new able to global lenders of last resort, example, the Bulgarian central bank framework, which was announced on FX swaps rank higher than repos. FX needs to have euro-denominated se- August 19, 2020. We then outline a swaps create stability by protecting curities – rather than its own domes- more rigorous and systematic global against volatility. In an FX swap, two tic currency – to post as collateral to Lender of Last Resort (LoLR) function countries’ central banks “lend” each the ECB to receive euro liquidity in re- based on three pillars: other some of their own currency. turn. Because securities are consid- ered more risky than cash, the repo 1. A global and European network of Let’s take a swap between Bulgaria loan may also be subject to “haircuts” FX swap lines to ensure appropriate and the ECB as an example. The Bul- on collateral. To account for variation distribution of euros and other hard garian central bank has a euro depos- in the market value of these securities, currencies across the EU and the in- it and that account gets credited with haircuts may be complemented by a ternational financial system; the agreed sum in euros, at an agreed daily variation margin. Repo collater- exchange rate and for an agreed peri- al is more difficult to service because, 2. A structural repo facility for foreign od. Bulgaria pays interest on this loan when the price of collateral falls, the central banks to ensure the global li- of currency back to the ECB. But in re- Bulgarian central bank needs to send quidity of euro area collateral; and turn for euro liquidity it also creates
No. 04 | February 2021 3 COMMENTARY Three Ideas to Improve the International Role of the ECB the ECB additional collateral to make between central banks. Repos are still 1. An emergency facility to deliver euro up the value of the swap again. the preferred method by which the liquidity in times of distress and help Central Bank offers liquidity to com- liquify the foreign exchange reserves The ECB resorts to double standards mercial banks, adjusting the eligible of central banks at Europe’s periphery. in its treatment of EU member states collateral and the haircut proportional- by offering liquidity on different terms ly to the perceived counter-party risk, 2. A structural facility to improve the to some nations. These double stan- the quality of the collateral, and the flow of euro collateral and offer both dards can be difficult to understand. daily variation in the price of collateral. repo and reverse repo windows to for- For example, why would the National eign central banks outside of Europe Bank of Hungary enjoy a repo line and FX swaps are less onerous for count- to encourage the use of euro assets in not the National Bank of Poland? Why er-party central banks because there is their reserves as a liquid store of value. would the Danish National Bank enjoy an established exchange rate between a full swap line rather than a mere re- currencies. That means collater- The ECB should instead consider a po line when Denmark is not part of al doesn’t need a haircut to match the simpler framework with three distinct ERM2 – the managed exchange rate value of the liquidity received. Swaps facilities, detailed below: mechanism used in the transition pe- are, in principle, reserved for central riod before a country joins the single banks whose currency is more trust- 1. A Global and European FX Swap currency – and does not intend to join ed or stable. However, this judgement Line Network the currency union? Meanwhile, Ro- of trust establishes a political distinc- This would put in place a permanent mania – part of ERM2 and a country tion between trusted official peers and and unlimited swap line facility with that is openly committed to entering less trusted ones. This process of mak- the G10 and all the EU’s central banks, the eurozone – only enjoys a repo ar- ing distinctions is questionable within without discrimination. The heart of rangement. There are numerous such the EU and for countries on the EU ac- this agreement would essentially be examples of double standards. But cession track. the current permanent core swap line there seems to be a political ratio- network (Federal Reserve, ECB, Bank of nale beyond financial stability consid- The creation of the Eurosystem repo England (BoE), Bank of Canada (BoC), erations for these distinctions. This facility for central banks (EUREP), fol- Bank of Japan (BoJ)). could explain why Croatia (an EU lows a similar move that was made by member state) would enjoy a swap line the US Federal Reserve, and includes In practice, this would see the ECB while Serbia and Albania only have a two important functions that should play a nodal role in distributing US repo line. But then why leave out Mon- be disentangled: dollars and euros to all European cen- tenegro, which is on the EU accession tral banks, ensuring a stable flow of track and has unilaterally adopted the euro as its currency? A NEW PERMANENT SWAP NETWORK Does the ECB introduce a political judgement on the various countries’ accession prospects? Or is it that the ECB does not want to sanction unilat- Danish Bank of Bank of National eral adoption of its currency? Wheth- Canada Japan Bank er it is one or the other, it should be spelled out with more clarity to justi- • Bank of Bulgarian National PERMANENT Mexico fy the policy. • Bank Federal S TA N D I N G ECB Bank S WA P L I N E S Reserve G LO B A L TO A L L of Korea F X S WA P L I N E EU COUNTRIES •… Swedish Riksbank THE IMPORTANCE OF Swiss Croatian REPO LINES FOR FOR- Bank of National National EIGN CENTRAL BANKS England Bank Bank ……… Because swaps rank higher than re- T E M P O R A R Y S WA P pos in the hierarchy of financial in- PBoC LINE FOR TRADE AND INVESTMENT struments, it is usually the instrument SETTLEMENT of choice for liquidity transactions Source: ECB | own illustration
No. 04 | February 2021 4 COMMENTARY Three Ideas to Improve the International Role of the ECB USD and EUR across the European fi- A DISCRETIONARY SWAP WINDOW FOR nancial system. BALANCE OF PAYMENT ASSISTANCE The ECB would continue to have a bi- lateral swap line with the People’s Bank of China (PBoC) designed to facilitate trade and investment flows rather than financial stability. This would both fa- IMF program cilitate the internationalization of the RMB, which serves the purpose of a EU’s Macrofinancial Assistance more multipolar, international mon- etary system and expand the use of the euro in China while promoting a more multipolar international mone- tary system. Banque 2. A Structural Repo and Reverse ECB du Liban Repo Facility for Foreign Central Banks The ECB should offer temporary and Source: ECB | limited repo lines to selected count- own illustration er-parties for the purpose of facilitat- ing trade and investment settlement. This would be particularly useful, for and the EU Macro Financial Assistance quidity risks in euros across the world instance, for countries that trade with Programme. While it may sound like – and to expand the role of the euro Europe but in which the banking sys- this facility would duplicate the IMF’s among foreign central banks. tem does not facilitate international work, in the 1980s and 1990s it was commerce (think of African coun- rather common for IMF programs to The ECB has an opportunity to ex- tries with weak correspondent bank- be complemented by Federal Reserve pand its pivotal place in the interna- ing links); or for countries with highly swap arrangements. When these be- tional monetary and financial system euro-ized banking systems that are came harder to come by, G10 cen- as one of the few central banks that is not in the EU, such as Serbia, Turkey, tral banks were called on to step in via connected to both the People’s Bank or Lebanon. the Bank for International Settlements of China (PBoC) and to the US Fed- (BIS). This happened in 1995 during eral Reserve, but, in order to do so, it Opening a standing repo and reverse Mexico’s peso crisis, which led to a $50 must accept further operational and repo line to all foreign central banks billion bailout package. An emergency counter-party risks. These are inev- (with varying haircuts) would offer assistance facility could be very use- itable if the euro is to rise as a lead- advanced custody and payment ser- ful today, for example to address Leba- ing international reserve currency and vices in euros to all central banks. But non’s financial cum banking crisis. help reshape the international mone- it would also ensure the highest pos- tary order. sible level of international euro collat- eral fluidity, which is important for the CONCLUSION conduct of the ECB’s domestic policy and the control of its short-term se- The European Union wants to pro- cured funding rates. mote the international role of the euro in order to reap the benefits of issu- 3. A Discretionary Emergency Assis- ing a true international reserve cur- tance Facility rency and provide a more stable and The ECB should also consider creat- multipolar international monetary or- ing a standing FX swap and/or repo der, but the ECB’s framework for swap facility that can be accessed in cases and repo lines is not up to the task. It of distinct country-level distress – in should be revised profoundly to pro- particular alongside existing financial vide a simpler and more systematic assistance programs such as the IMF set of instruments to limit potential li-
No. 04 | February 2021 5 COMMENTARY Three Ideas to Improve the International Role of the ECB Rauchstraße 17/18 10787 Berlin Tel. +49 30 254231-0 info@dgap.org www.dgap.org @dgapev The German Council on Foreign Relations (DGAP) is committed to fostering impactful foreign and security policy on a German and European level that promotes democracy, peace, and the rule of law. It is n onpartisan and nonprofit. The opinions expressed in this publication are those of the author and do not necessarily reflect the views of the German Council on Foreign Relations (DGAP). Publisher Deutsche Gesellschaft für Auswärtige Politik e.V. ISSN 1864-347 Editing Gareth Davies Layout Luise Rombach Design Concept: WeDo Author picture(s) © DGAP, private This work is licensed under a Creative Commons Attribution – NonCommercial – NoDerivatives 4.0 International License.
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