European Union tightens lending rules

Frankfurt: The European Central Bank toughened up its lending rules Wednesday, saying that from next year banks will face higher penalties if they use weaker-rated assets as collateral to borrow ECB cash.

Banks in Greece, Portugal, Spain and other heavily indebted parts of the euro zone have been locked out of normal bank-to-bank lending markets during the most turbulent periods of the financial and debt crises, leaving them almost entirely dependent on the ECB for funding.

The ECB's new sliding-scale of ‘haircuts' percentages it takes off collateralised assets' values to protect itself — will come into force at the start of next year and cover most collateral accepted by the ECB.

Haircuts for sovereign debt rated in the AAA to A- range have not been changed, however, while asset-backed securities, hard to value assets that critics say played a key part in the financial crisis, also keep their own stricter penalties. "The new haircuts will not imply an undue decrease in the collateral available to counterparties," the ECB said in a statement.

Haircuts will range from 0.5 per cent for top-rated government debt to an eye-watering 69.5 per cent for low quality "inverse floaters" instruments typically issued by companies to protect themselves against interest rate increases.

In addition, uncovered bank bonds — the most popular type of collateral used at the ECB last year will carry tougher penalties than under current rules if they have a year or more until maturity.

Marked down

The changes were more wide-ranging than originally hinted at back in April. A-rated collateral will also be marked down, as opposed to purely sub-A debt as previously expected.

Last year around two-thirds, of the 2 trillion euros (Dh9.5 trillion) worth of collateral banks used to borrow ECB cash fell into the category covered by the new rules.

Only around 4 per cent of collateral parked by banks was graded below A quality in 2009. However, that could change now the ECB has formalised its acceptance of lower-rated assets.