In an unannounced mid-term meeting, the ECB board decided this week to add one more measure to the long list of measures already taken to help the economy through the corona crisis.
The bank will freeze the ratings of companies and countries. Until September 2021, the ECB will use the ratings as they stood on April 7, 2020. Any downgrades in creditworthiness after April 7 will have no consequences for collateral purposes, provided the rating remains at least BB. The central banks of the euro countries may also temporarily accept as collateral assets that do not meet the eligibility criteria. Consider, for example, loans to the SME sector with a guarantee from the governments.
Reduce collateral
Greek government bonds can now also serve as collateral for loans from the ECB, which has not been the case since the euro crisis. This mainly benefits the Greek banks. The ECB temporarily accepts more risks on its balance sheet by lowering the haircut on collateral by 20% across the board.
Haircut is the percentage by which the ECB reduces the value of the collateral for extra security. For example, if a bond is worth €100, the ECB will act as if the value is €80, for example. In this way, the bank protects itself in the event of bankruptcy of the counterparty or decline in value of the collateral. The ECB estimates that this will allow eurozone banks to borrow around €140 billion more from the ECB.
Creditworthiness at risk
The aim is to guarantee the availability of collateral that banks must have to borrow money from the ECB. Even if countries and companies see their creditworthiness decline in the near future. The chance of credit rating downgrades is high, given the crisis. But this can often mean that companies that are fundamentally healthy and temporarily face headwinds due to the corona crisis, receive a lower rating.
If policy remains unchanged, these companies will be less likely to obtain capital or not at all, which in turn could deepen and worsen the crisis. The ECB also wanted to avoid possible problems, which is why the bank took proactive action. By giving the national central banks more space, the ECB also provides more flexibility. The ECB indicated that it would take new measures, if necessary, to mitigate the consequences of credit rating downgrades.
External shock will pass
In my view, the latter means that we must take into account that if the credit rating cuts are disappointing, the ECB will lower the floor further. The decision to temporarily freeze the creditworthiness of loans to eurozone banks appears to be an excellent measure, from a macroeconomic point of view, given the economic situation. The ECB ensures that countries/companies that become less creditworthy due to the corona crisis (external shock, which will pass) do not encounter additional problems that could turn a temporary problem into a permanent one, i.e. ruin.
That said, the promise not to rule out further measures to mitigate the effects of further credit downgrades could have an undesirable effect. There is a danger that the ECB will go beyond the above (= helping companies through a temporary problem situation) and will structurally support countries/companies that become less creditworthy for reasons other than the corona crisis. This is an economically unwise policy, interference with market forces, and therefore goes far beyond the limits of monetary policy.
It is therefore understandable that the ECB does not want this measure to last too short, but chooses a longer period for the sake of peace and quiet. However, I would have liked to hear from the bank that it will reverse this measure if the economic situation normalizes before September 2021.