The Central Bank is not only for banks – Newspaper Kommersant No. 65 (7510) dated 04/14/2023

The work of economists of the European Central Bank (ECB) in April 2023 discusses an issue that previously could not be discussed in principle in a modern economy. Based on the “forced experiment” of March 2020, the ECB states that under the current logic, the provision of liquidity by an issuing bank to a non-bank intermediary in the financial market – acting as a lender of last resort – is rational “under abnormal conditions”.

The work of ECB economists Johannes Breckenfelder and Marie Goerova “Do non-banks need access to a lender of last resort? The Experience of Escape from Funds” was published in the “Working papers” series of the European Issuing Institute. Formally, the document is not the position of the ECB (more precisely, its governing structures), but a scientific work, but in this series the bank rather states the view of its economists on the problem, and does not offer to discuss it. Meanwhile, even 20-30 years ago, the topic could have been considered impossible: Johannes Breckenfelder and Marie Goerova cautiously suggest agreeing that the central bank (in this case, as an issuing institution, and not a regulator of the banking sector or, as in Russia, a mega-regulator of the financial market) can effectively act as a lender of last resort for non-banking financial intermediaries, that is, intermediary structures that “do not produce money” in terms of the fractional reserve banking system.

The text, however, analyzes not ordinary banking crises, but the situation of March 2020: the peak of the collapse in financial markets associated with the announcement of the COVID-19 pandemic by the World Health Organization led to an instant liquidity crisis in financial systems around the world, which both the ECB and The US Federal Reserve solved with large injections, including under the asset purchase programs from banks (APP and PEPP) with a starting limit of €750 billion in the case of the ECB (the expansion limit is €1.85 trillion), and then the Bridge LTRO programs, during which banks borrowed more than €100 billion from the ECB. Some of the securities under which central banks provided liquidity to banks were involved in repo transactions, and a considerable share of them belonged to collective investment funds and investment funds. The latter also experienced problems similar to banking ones: in a panic similar to a bank run, clients closed their positions (fire sale), funds experienced acute liquidity problems, but they could not use the ECB and the Fed as lenders of last resort, relying only on the market, shareholders and asset pledges. The interventions of March 2020 themselves helped through the flow of liquidity from banks to funds, including (the situation in the USA in October 2018, where the Fed did not go for a massive injection of liquidity, is used as a “placebo test”). But Johannes Breckenfelder and Marie Goerova are essentially asking the question: would it be better (and to whom) if the funds in March 2020 received liquidity directly, rather than through bank balance sheets and repo markets?

Authors’ answer: direct support for non-bank borrowers would be much more effective than APP, PEPP and Bridge LTRO for a number of reasons, including regulation of flows between separate parts of the financial system, and the elimination of the problem of margin calls for funds in case of their direct lending by the central bank on the horizon from a year would increase the profitability of funds by 3.6 percentage points, would reduce the volume of fire sales by 61%. Making all the necessary reservations about the moral hazard problem for funds whose clients would be saved from losses by such interventions, saving non-bank investors from market losses by the issuing institution and the impossibility of such a strategy for a “normal situation” (a pandemic is automatically recognized as an “abnormal situation”, speech by the logic of the authors it is not about the realization of market risk, which must be taken into account and there is no possibility to insure), ECB economists come to the conclusion: yes, such an expansion of the functions of the central bank could be useful, effective and would reduce the loss of general welfare.

The question of whether the insurance of the Central Bank for the non-financial market is acceptable, obviously, is waiting for its researchers.

Dmitry Butrin