Would the ECB downgrade France?

June 29, 2012

By George Hay

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The European Central Bank rightly wants to loosen the grip of ratings agencies. That is why it’s considering the use of its own internal ratings system for the collateral that banks can swap in its liquidity operations. But like any do-it-yourself solution, this could easily end in a botch job.

Everyone seems to agree that the likes of Moody’s, Standard & Poor’s, and Fitch wield too much power. Having goofed in missing the subprime crisis, ratings agencies are now having an equally baleful impact on the splintering euro zone. When they downgrade sovereign debt, banks have to pledge more collateral with the ECB to tap its liquidity operations. The public nature of these downgrades means investors in turn push up banks’ cost of funding.

Were the ECB to instead devise ratings in-house, it could conceivably halt a nasty side effect of visible ratings actions. And if the ratings were kept private, the feedback loop might lose its fuel.

But it is unclear how the bank could keep a downgrade hush-hush. Repo desks around Europe would presumably need to know the ratings for their own trades.

What’s more, the ECB’s secret ratings might not be tough enough. Just look at how the central bank has moved the goalposts throughout the crisis to keep banks with low-quality collateral in the game. Following the first Greek bailout in 2010, it allowed Greek banks to repo non-investment grade collateral. Then it said it would accept ordinary loans in its pan-European longer-term refinancing operations in late 2011 – and on June 22 expanded the criteria again.

Northern Europeans would fret that private ECB ratings would mean soft ratings, and a bigger bill for them if they ever had to rescue the central bank itself. There’s also a political aspect. At present, the ratings agencies are a useful fall guy when the ECB withdraws liquidity from rickety peripheral banking systems. An ECB-penned downgrade could create some major public spats if the target was in the core. Would the ECB dare downgrade France?

The ECB may have to settle for constraining rather than the agencies’ power. More brainstorming is needed over in Frankfurt.

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