Tracking the ELA

Author: Tessa Milligan, Post Date: September 6, 2012
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Introduction

Emergency Liquidity Assistance (ELA) is a special loan facility as part of the European System of Central Banks, provided through the national central banks (NCBs) of individual EMU member countries. It allows the NCBs to provide emergency liquidity funding to domestic financial institutions that are experiencing financial distress. However, the provision of ELA creates moral hazard, because the NCBs take on the responsibility of any losses that are incurred if financial institutions fail to repay the ELA. Although ELA is provided by NCBs, the ECB is informed by the granting NCBs of the amount of ELA provided, so it can take into account the total amount of liquidity available within the system as it executes monetary policy. The ECB can also stop ELA provision with a two-thirds majority vote of its governing council if it sees fit.

Prior to April 20, 2012, the European Central Bank (ECB) did not specifically disclose the amount of outstanding ELA, since the information was included in “Other Securities” and “Other Assets” in European System of Central Banks consolidated financial statements. The ECB revealed the aggregate amount of ELA in the eurozone as of April 20, 2012, when it moved ELA out of the “Other Securities” and “Other Assets” items and into “Other Claims on Euro Area Credit Institutions Denominated in Euros” (asset item 6). This accounting reclassification revealed a total amount of 121.14 billion euros of ELA in the eurozone as of April 20. The items of the financial statement are updated weekly, but the total amount of ELA each week after April 20 is unknown, because it is consolidated with the other components of the Other Claims item. This makes it difficult to determine how much institutions are borrowing to meet their normal short-term needs for liquidity, and how much represents ELA. The purpose of this paper is to suggest a methodology for segregating ELA from the other components of the Other Claims item, in order to estimate total ELA provided in the eurozone.

What are the terms and conditions of ELA?

ELA is provided through and is the liability of the granting NCB. The ECB can stop ELA with a two-thirds majority vote if it believes that the ELA would interfere with the “objectives and tasks of the ESCB.”[1] According to the ECB, ELA can only be provided when there are “systemic stability aspects at stake” or in the case of an emergency. The ECB also stipulates that ELA can only be used temporarily, be provided against adequate collateral, and be issued to illiquid but solvent institutions.[2] However, these terms seem to be highly subjective, considering the length of time that the ELA facility has been in use in Ireland and the insolvency of the Greek banks that use ELA to meet demands for withdrawals.

The problem is that only three NCBs disclose information about ELA to the public. Amounts haven’t been disclosed, because of the fear that the disclosure of the amount of ELA provided to their countries’ financial institutions would have a negative effect on public confidence, generate bank runs, and further increase stress on financial institutions. The ECB and the NCBs must report ELA provision in their accounting records. However, in an effort to avoid revealing the amount of ELA to the public, they combine it with other things in the Other Claims item of the weekly consolidated financial statement. The other components of Other Claims include “current accounts, fixed-term deposits, day-to-day money and reverse repo transactions in connection with the management of security portfolios held under asset item 7.”[3] As a result, estimated ELA outstanding in each country must be derived using data in the balance sheet at a historical level.

Because the NCBs are secretive about ELA, much about ELA remains unclear. Usually there is a two- or three-month lag between the end of an accounting period and the release of an NCB’s balance sheet, and the current date so it is difficult to determine the total current ELA outstanding in each country on a timely basis. In addition, some of the conditions under which ELA is provided are also obscure. We know very little about the way in which ELA is funded and the requirements regarding collateral, interest rates, and maturity.

Where can data on outstanding ELA borrowing be found?

The approximate amount of ELA in each country can be found in the balance sheet of each NCB under “Sundry,” “Other Assets,” or “Other Claims on Euro Area Credit Institutions.” Currently, we are aware of three countries that have provided ELA in the past year: Ireland, Cyprus, and Greece. Figure 1 shows approximate monthly totals of ELA in each country from 2011 to 2012, rounded to the nearest billion.

Figure 1. Emergency Liquidity Assistance Estimates (bn. EUR) 2011-2012

ELA in Ireland peaked at approximately 69 billion euros in February 2011 and has been decreasing since then. Irish ELA used to be listed under the “Other Assets” column of the Central Bank of Ireland’s balance sheet. In April 2012, an accounting reclassification took place, moving the ELA to “Other Claims on Euro Area Credit Institutions.” The accounting reclassification reveals that Irish ELA was 41.35 billion euros in April 2012.

The Central Bank of Cyprus disclosed a total ELA amount of 3.55 billion euros in December 2011. In April 2012, ELA was moved from the “Other Assets” item of the balance sheet to “Other Claims on Euro Area Credit Institutions.” In July 2011, the total of the Other Claims item of the balance sheet of the Central Bank of Cyprus was approximately 10 billion euros.

Greek ELA seems to have started around July 2011. In January 2012, the Central Bank of Greece disclosed ELA operations with a total of 54 billion euros. The “Sundry” item of the monthly balance sheet of the Central Bank of Greece peaked in May at 124 billion euros, most of which is ELA. In April 2012, ELA was moved from the “Sundry” item to the “Other Claims on Euro Area Institutions” item of the monthly balance sheet. As of July 2012, the total of the Other Claims item was 106 billion euros, most of which is ELA.

Methodology for Estimating Total Weekly ELA in the Eurosystem

In order to extract ELA from the aggregate, it is necessary to find a proxy. We propose a measure using the spread of the French ten-year bond over the German ten-year bond. The hypothesis is that the demand for non-emergency, everyday liquidity funding can be captured in the variation of the French-German ten-year spread. Germany’s ten-year bond is the most creditworthy benchmark in the euro area, followed by France’s ten-year bond. When the French-German spread widens, it indicates a systematic demand for liquidity. When the spread narrows, it is evidence that the market system is liquid and the excess funds are being paid back. Therefore, a narrow spread signifies a lower demand for ELA. Once the demand for normal liquidity funding from the NCBs has been estimated, we can derive an estimate of ELA.

We regress the weekly Other Claims data, which exclude ELA from January 1, 2009 to April 13, 2012, on the French-German spread, using the current spread and two lagged values to capture possible momentum in borrowing and liquidity demands. Figure 2 shows the results.

Figure 2. Statistics Summary of Auto Regression of Weekly Other Claims Data and France-Germany Ten-Year Spread

The estimated equation in Figure 2 is used to forecast the weekly Other Claims data after April 13th, which is then subtracted from the reported Other Claims to estimate the weekly ELA total in the eurozone. Figure 3 decomposes the weekly Other Claims data reported in the ECB’s financial statement into estimates of the ELA and the other components of Other Claims, from April 20, 2012 to the present.

Figure 3. Emergency Liquidity Assistance in the Eurozone (bn. EUR)

As shown in Figure 3, the predicted Other Claims and actual Other Claims values track each other very closely and are relatively equal prior to April 20, 2012. This leads us to conclude that the forecasted Other Claims provides a reliable and useful estimate. After the Other Claims item was adjusted to include ELA, it increased drastically, starting at 183.69 billion euros on April 20, 2012 and peaking at 250.59 billion euros on June 1, 2012. ELA provided on April 20, 2012 was 121.14 billion euros, as stated in the ECB’s financial statement. Our model suggests that ELA peaked on June 1, 2012 at approximately 189.5 billion euros.

Since June 1, 2012, the Other Claims item has been decreasing. On July 27, 2012, the ECB reported 225.9 billion euros in Other Claims. We estimate that total ELA in the Eurozone on July 27, 2012 was approximately 165.9 billion euros. Figure 4 shows an area chart, with the approximate ELA in each country in the eurozone as a part of the aggregate ELA estimate.

Figure 4. ELA Estimates by Country (bn. EUR) April 2012 – July 2012

Based on the information provided in the balance sheets of the NCBs, we estimate that ELA was approximately 106 billion euros in Greece, 41 billion euros in Ireland, and 10 billion euros in Cyprus in July 2012. These three figures are equal to a sum of 157 billion euros, which makes up the majority of total ELA outstanding in the eurozone. This is 8.9 billion euros less than the estimate for aggregate ELA on July 27, 2012. This suggests that the financial difficulties widely reported to be affecting Spain, Italy, and Portugal, just to name a few countries, have not yet resulted in strains significant enough to trigger significant ELA borrowing. One explanation for this could be the loosening of the collateral standards required to be eligible for funding by the ECB.

As stated in the ECB’s press release of June 22, 2012, “The Governing Council has reduced the rating threshold and amended the eligibility requirements for certain asset backed securities (ABSs). It has thus broadened the scope of measures to increase collateral availability which were introduced on 8 December 2011 and which remain applicable.” This could explain the decrease in the Other Claims item of the ECB’s financial statement during the months of June and July and the reduced likelihood that ELA credit would need to be extended. As a result of the ECB’s decision to reduce the collateral standards, more banks met the eligibility requirements for funding by the ECB. The funds that are borrowed from the ECB are listed in the ECB’s financial statement under “Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euros” (asset item 5).

Conclusion

In summary, ELA has become an increasingly important device used in the eurozone to maintain liquidity during times of financial distress. We were able estimate the total weekly ELA using historical Other Claims data and the French-German ten-year spread. We were also able to find approximate ELA in Greece, Cyprus, and Ireland. Although ELA has decreased since June 2012, the current estimate of total ELA is still substantial. Additionally, it is worth noting that the decrease in ELA may not reflect economic recovery. Instead, it may be a result of lower standards for the borrowing of funds from the ECB.

Thank you to David Kotok and Robert Eisenbeis for encouraging me to write this paper and for offering their guidance. Their knowledge and contributions were invaluable during this process. It has been a pleasure learning from the two of them.

[1] Article 14.4 of the Treaty on the Functioning of the European Union

[2] The opinion of the European Central Bank of 24 January 2012 states, “The relevant criteria are the following: (i) it must be ensured that the credit provided by the NCB is as short term as possible; (ii) there must be systemic stability aspects at stake; (iii) there must be no doubts as to the legal validity and enforceability of the state guarantee under applicable national law; (iv) there must be no doubts as to the economic adequacy of the State guarantee, which should cover both principal and interest on the loans, thus fully preserving the NCB’s financial independence.”

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