For several months now it has been apparent that the ECB's relaxation of collateral rules in order to keep Spain's banks solvent is imperiling its balance sheet. Despite claims to the contrary, there are very real risks involved with a central bank taking on mountains of risky debt, not the least of which is the credibility problem which would come from operating from a negative equity position in the event the collateral goes bad and blows a huge hole in the asset side of the balance sheet. On Sunday, the ECB announced it is reviewing its own collateral policy in connection with securities originating in Spain.
Over the weekend, the German newspaper Welt am Sonntag did some digging and discovered that, low and behold, the ECB doesn't appear to follow its own collateral rules when accepting Spanish T-bills:
"The problem is that T-bills no longer fulfill the conditions for [a] first-class credit rating. Papers from 66.5 billion euros are really just second class and should therefore under ECB rules [be] provided with a higher discount of 5.5 percent - which would mean 3.3 billion euros less credit for the banks. The remaining T-bills in [the amount] of EUR 13.3 billion [are] only mediocre - they [should] no longer [be] accept[ed] by the central bank as collateral." (Google translation edited for clarity)
In the event the ECB applied its own rules strictly, the Spanish banks which pledged the Bills would have to come up with nearly 18 billion euros worth of additional collateral to back the loans they received. Given the state of the Spanish banking sector, I think it goes without saying how difficult this would be.
As the Wall Street Journal notes, the issue strikes at the heart of the ECB solvency issue:
"[The ECB's investigation] reviv[es] concerns over the safety of the central bank's €3 trillion ($3.85 trillion) balance sheet...[as] the ECB has long insisted that its balance sheet is safe, citing its collateral rules." (emphasis mine)
As reported by Die Welt (cited above) the ECB's justification for applying a "low A" (to quote the EU Observer) rating to the Bills is the relatively high marks afforded the notes by obscure Canadian ratings agency DBRS. Nevermind the fact that Moody's and S&P have the paper at 'B' (and even that is probably far too generous). According to DBRS' website, they offer "insight beyond the ratings" so perhaps they know something the larger ratings agencies do not.
Of course the reality here is that the ECB knows the collateral it is accepting isn't quality, it simply has no choice in the matter. If it doesn't accept the Bills, Spain's banks run out of cash. This is further evidence of the fragility of the ECB and the precarious character of the eurozone crisis and it is yet another reason to stay short European equities (FEZ) and periphery debt.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.