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June 2009 | ifr special report | 7 COLLATERAL “

Central banks to the rescue

Central banks have always accepted covered bonds as a form of collateral when lending to banks. Now, as the market struggles to recover from the credit crisis, a number of central bank initiatives are either explicitly or implicitly helping to re-establish covered bond trading.John Ferry reports.

The ECB sees covered bonds as a critical market that

needs to be repaired in order to get lending and economic growth going again.

n May, in an unprecedented move to help bolster lending markets, the European Central Bank announced it would buy €60bn worth of covered bonds. In late May the ECB was yet to release details of how exactly it would undertake its purchases, but the announce- ment itself immediately boosted confidence in the covered bond market, being quickly followed by a number of large issues of new instruments (for more on the ECB see previous story). “The announcement by the ECB gives a strong perception that this is a safe product,” said Bernd Volk, Frankfurt-based head of European covered bonds research at Deutsche Bank.


As well as agreeing to directly buy covered bonds, the ECB also announced it had extended the maturity on its repo transactions. “Repos are usually only short- dated, three months or so transactions, which meant banks had to roll their positions, but the ECB has extended this to


100 80 60 40 20 0

2004 Source: ECB 2005 2006 2007 2008

Non-marketable assets Other marketable assets Asset-backed securities Corporate bonds Covered bank bonds Uncovered bank bonds Regional government securities Central government securities

12 months,” said Volk. This enabled banks to post covered bonds as collateral and borrow for longer, locking in the current historically low rates. Jean-Claude Trichet, president of the ECB, said the steps, along with a 25 basis point fall in its benchmark interest rate to 1%, should encourage banks to maintain and expand lending and improve market liquidity. Central banks have long accepted covered bonds as collateral when lending to banks via repos. The ECB’s buying programme, however, took it from a position of tacit support to explicit endorsement. “The ECB sees this as a critical market that needs to be repaired in order to get lending and economic growth going again,” said Ted Lord, head of European covered bonds at Barclays Capital in London. That may not be the end of the story. The ECB and other central banks have other reasons to want the covered bond market to recover. The originate-and-distribute

Breakdown of assets (including credit claims) put forward as collateral, by asset type

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