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Banks reel as ECB redraws funding rules

Section: Daily Dispatches

By Ralph Atkins, Anousha Sakoui, and Paul J. Davies
Financial Times, London
Thursday, September 4, 2008

Bank stocks in Europe and the UK fell sharply and the risk of owning their debt leapt on Thursday after the European Central Bank declared a crackdown on abuses of its bank liquidity operations.

Jean-Claude Trichet, ECB president, used his regular interest rate conference to announce rule changes more radical than had been expected. These will affect financial firms that have developed too great a dependence on cheap funding from the bank.

Mr Trichet announced a series of measures to increase the cost of using asset-backed securities to obtain ECB funds and to exclude some such deals when underlying mortgages or other loans are not denominated in euros. The announcement follows comments by ECB council member Yves Mersch last month. He said there were still cases where "you see dangers of gaming the system."

This year it emerged Macquarie Bank had constructed a deal backed by Australian car loans that could be used at the ECB, and Lehman Brothers had formed a huge collateralised loan obligation of risky buyout debt to use at the central bank.

Mr Trichet said the "general character" of its broad-based operations remained unaffected. "We're not changing it, we're refining it," he said.

Only a "small fraction" of collateral would be affected. Banks' ability to take part in its financing operations would be unimpaired, the ECB president said.

Analysts said the changes would affect banks sharply. It is "a further squeeze on banks, increasing the pressure on them to do more expensive longer-term funding ... when there is already investor concern about ... their existing refinancing needs," said Matt King, credit strategist at Citigroup.

UK banks saw the biggest share falls with HBOS down almost 7 per cent at 282.5p, Barclays down 6 per cent at 336.96p, and Lloyds TSB down 5.7 per cent at 288.9p. The worst-affected European banks were UBS of Switzerland and some smaller regional banks such as Erste Group of Austria and Piraeus Bank of Greece.

Since the credit squeeze a year ago, the ECB has boasted its broad-based system had proved more effective than those of other central banks. But in recent months fears have intensified that banks could be exploiting the system by -- for example -- using riskier collateral than envisaged to get ECB funds.

The changes, which take effect from February 1, include increases in the average "haircuts" applied to asset-backed securities. A haircut is the amount deducted from the market value of a product when judging its value as collateral. In future, a blanket 12 per cent haircut will apply, replacing a previous sliding scale of between 2 per cent and 18 per cent. There will be penalties for asset-backed securities valued using models and for unsecured bank bonds.

Restrictions already in place on banks using assets they themselves had formed were extended to stop banks using assets from issues to which they had offered currency hedges or liquidity support above a certain level.

Analysts at Barclays Capital said the extra haircuts would mean banks might have to post an additional E25 billion-E45 billion of securities for collateral purposes. "That could cost E375 million to E450 million annually to banks. ... Not in­significant, but probably bearable," said Laurent Fransolet, analyst at Barcap.

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