News that the European Central Bank has begun its programme of buying covered bonds from banks in Spain, France and Germany will only whet the market’s appetite for full-blown quantitative easing.
Covered bonds – considered palatable assets because they give the buyer dual recourse, to both underlying collateral and the issuing bank – are part of Mario Draghi’s recipe for lowering banks’ borrowing costs, boosting their lending, and strengthening the ECB’s own balance sheet. But, like the best amuse-bouches, Mr Draghi’s plan is being derided by some as wafer thin – in volume and substance.
On paper, at least, the opposite seems true. The ECB president has implied that the bank intends to buy a meaty €1tn of covered bonds and other asset-backed securities.
One ECB official has estimated that the value of outstanding eligible covered bonds was €600bn. However, because banks benefit from covered bonds’ low risk weights under the Basel III rules, they are unlikely to want to sell. According to some estimates, the ECB could potentially target about one-third of the eligible market – but it would be competing with existing investors, much to the latter’s chagrin.
New issuance is shrinking fast: only €91.7bn-worth have been issued in the year to date – the lowest total for nearly two decades, according to Dealogic.
Meanwhile, yields, which help to determine borrowing costs, are already on the floor. Average covered bond yields dropped below 1 per cent for the first time in June, according to Bank of America Merrill Lynch’s euro covered bond index. They currently stand at about 0.55 per cent after a record low of 0.48 per cent last week as investors made a dash for haven assets amid market turmoil.
Then there is the biggest obstacle: European banks do not need the ECB’s cheap financing help. If the ECB wants to have an appreciable effect on boosting lending, critics say it needs a plan to deal with the riskier assets on banks’ balance sheets that consume capital and hinder new loans. It should also target those bonds it can buy in super-large quantities, say analysts, such as sovereign debt.
A simple hors d’oeuvre of covered bonds will not do. The market wants a 12-course meal.