ECB adds ‘moral hazard’ to emergency liquidity assistance rules

ECB adds ‘moral hazard’ to emergency liquidity assistance rules

The European Central Bank warned that “moral hazard” could be a reason to object to the emergency liquidity assistance it allows lenders to access, just a day after it tightened conditions on the aid for Greece.

The Eurosystem’s functioning could be disrupted by “provision of ELA at overly generous conditions, which, in turn, could increase the risk of moral hazard on the side of financial institutions or responsible authorities,” the ECB said in a document published on its website Tuesday. “The objective of ELA is to support solvent credit institutions facing temporary liquidity problems. It is not a monetary-policy instrument.”

The document on the ECB’s financial-risk management clarifies the conditions surrounding emergency bank aid at a time when policy makers are restricting the provision of such funding to Greek banks. The reference to moral hazard indicates that officials are worried that bending the liquidity rules for Greece, as the country heads for a possible default, may lead future recipients to act less responsibly.

On Monday, the ECB increased the discounts on collateral for lenders receiving ELA from the Bank of Greece. That makes it more difficult for banks to access the funds that have kept them alive as deposit withdrawals accelerated amid uncertainty over the country’s place in the euro.

While the risk of ELA is nominally borne by the national central bank that provides it, the Frankfurt-based ECB has broad discretion over the terms. The new document didn’t specify what would quantify “overly generous” provision.

Policy threat

An older public version of the ECB’s rules stated that ELA recipients should be solvent and that the funding shouldn’t “interfere with the objectives and tasks of the Eurosystem.” The new document goes further.

The ECB said ELA shouldn’t represent “a threat to the singleness of monetary policy,” or “a threat to the implementation of monetary policy, for example by making the steering of short-term rates more difficult.”

ELA also shouldn’t be “a threat to the financial independence of the national central bank, for instance if ELA was not provided against sufficient collateral to safeguard such independence,” it said.

The ECB reiterated a key limit on its freedom of action, namely the provision in European treaties that prevents it from funding governments. ELA should not give rise to “an obvious concern about a possible breach of the monetary financing prohibition,” it said.

In 2014, the ECB said it was concerned about the risk of monetary financing implied in an arrangement introduced by the Irish central bank, which replaced collateral posted against ELA loans for government bonds.