Standing high to reassure the fallen

Brussels: European Central Bank chief Jean-Claude Trichet had no money to offer in the bailout of Belgian-Dutch bank Fortis but came with something nearly as important - the backing of Europe's most credible institution.

Trichet joined Belgian Prime Minister Yves Leterme in Brussels on Sunday for discussions about how to secure the future of Fortis, which ended in an 11.2 billion euro ($15.6 billion) bailout by the Belgian, Dutch and Luxembourg governments.

Although the ECB has no direct role in financing bank rescues and has made no comment on the deal, analysts said Trichet's presence at the talks was a vital show of support.

"There's no role for the ECB in solvency issues but it's important that Jean-Claude Trichet was there holding hands," Deutsche Bank economist Mark Wall said.

"Having the ultimate monetary authority head of Europe participating - even in an oversight or advisory capacity - shows that the appropriate coordination is going on."

The ECB has won respect over the last year for taking the lead in providing emergency liquidity to troubled banks, offering a wide range of term lending and accepting a broad range of assets as security for the loans.

Approach copied

Other central banks, including the Bank of England and the US Federal Reserve, have copied the ECB's approach in extending their loan operations and collateral lists, but the ECB is widely seen as the benchmark.

When it comes to bank rescues, the ECB also takes a different approach.

The Fed, for example, not only takes an active role in brokering bank rescue packages but also has the power to back these up with hard cash, as shown in deals for investment bank Bear Stearns and insurer American International Group.

In contrast, the ECB and the euro zone's 15 national central banks provide liquidity support but do not have the power to shore up institutions facing a solvency crisis.

Although central banks would normally be involved in discussions about rescue plans for troubled banks, ultimately the buck stops with the government of the country or countries the institution is based in, and its taxpayers. "If it concerns solvency, you need someone to write a cheque," Morgan Stanley economist Elga Bartsch said.

"That in Europe is somewhat more cumbersome, but the fact that we have different banking systems working as a patchwork means that some of them may prove to be better run from others. We will learn in this crisis what works well and what does not."

Liquidity support can come via the ECB's regular open market operations, which it has beefed up over the last 14 months in a bid to kick-start paralysed money markets.

Banks can also access an overnight loan facility which charges a premium of one percentage point over the ECB's benchmark rate, currently 4.25 per cent.

In addition, euro zone central banks act as lenders of last resort in that they can provide emergency lending to solvent institutions if these are faced with a loss of confidence, or a bank run.

Under an emergency liquidity scheme, the national central bank or banks can provide special funding to a troubled bank, against collateral, on a case-by-case basis, as part of their mandate to help ensure financial stability.

Economists said that the swift agreement on Fortis was a hopeful sign for dealing with any future crises at cross-border banks, which remain a grey area under European Union law, and should shore up investor sentiment.

Mistrust

"There's a lot of mistrust in the market which I do understand but this is being resolved, it's being resolved by the governments and the supervisors," said Sylvester Eijffinger, professor at the Netherlands' Tilburg University. "I would say it's the beginning of the end [of the problems]."

Still, the deal did not prevent Fortis shares dropping almost 24 per cent on Monday amid a wider fall in banking stocks and econ-omists said the only permanent solution was an overhaul of patchwork fin-ancial regulation arrangements and more clarity on the division of labour between financial, monetary and political authorities.

At the moment, for example, some euro zone central banks have responsibility for bank regulation and supervision, some do not, and some share the mandate with an independent regulator.

The ECB has long called for a better flow of information between regulators and central banks, and has made it clear it would not be opposed to taking a more active supervisory role itself, without going as far as fixing solvency crises.

"The ECB should deal only with liquidity problems but sometimes it's quite difficult to untangle the two," said Paul De Grauwe, a professor at the Catholic University of Leuven in Belgium.

Still, now was not the time for an overhaul of regulatory arrangements, he said. "While you are extinguishing the fire you don't want to be dealing with the building code."