Money markets ecb repayments point to more use of emergency funds

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* ECB repayments indicate increased emergency funding* Reliance on some national central bank cash growingBy Kirsten DonovanLONDON, May 28 European Central Bank accounts for the last week are set to show banks made further early repayments of cash obtained through longer-term liquidity operations, highlighting the trouble some institutions are having funding themselves. More than 21 billion euros of longer-term refinancing operation (LTRO) cash was repaid last week, including around 9 billion euros of funds from December's three-year funding bonanza. That is on top of an almost 11 billion euro repayment earlier in May. But that fall in the outstanding amount corresponded with a rise in the ECB's balance sheet item that accounts for the Emergency Liquidity Assistance (ELA) funding provided by national central banks. The weekly balance sheet, published on Tuesday for the previous week, is expected to show a similar shift in funds.

Commerzbank rate strategist Benjamin Schroeder suggests this may be linked to credit rating agency Fitch's downgrade of Greek covered bonds to "junk" that made such paper ineligible as collateral at the ECB. Technically, banks are not permitted to repay LTRO funds early. There are exceptions for the December and February three-year funding operations, but even those officially cannot be repaid before one year has passed unless a bank runs out of eligible collateral or loses status as a ECB counterparty."You're getting this Balkanisation, where you're dividing up the risk and apportioning it through the national central banks," said RBS rate strategist Simon Peck.

"At the end of the day banks are getting the liquidity that they need, be it from the ECB or the ELA....but it just depicts the ongoing fragmentation that we have seen for some time now."National Central Banks are able to accept, at their own discretion, lower quality collateral than the ECB, allowing banks to acquire the funds necessary to keep operating. But that is not without its risks should the borrowers be unable to repay the cash.

"The concern is that...if the central bank has to mark this collateral to market (prices) it could be sitting on quite sizeable losses if the recipients of this funding can't repay it," said Rabobank rate strategist Richard McGuire."It gives the lie to the notion that the ELA lending is ringfenced and not a euro system the euro system would probably have to backstop those losses."The 11 billion euros of LTRO repayments earlier in the month were believed to be linked to the ECB's move to stop providing liquidity to Greek banks left temporarily undercapitalised after the Greek debt swap. The exact amount of funding taking place through regional ELAs is not definitively clear, but the ECB's balance sheet item reflecting it - other claims on euro area credit institutions - has risen by over 150 billion euros since the beginning of April alone, highlighting the increasing reliance on such funding."It becomes more of an issue if the rules regarding what is considered as acceptable collateral were to change," RBS' Peck said."But ELA facilities are emergency facilities, so you would expect by nature of their design that the collateral rules would remain sufficiently soft".