Tags: ecb | bond | crisis | europe

ECB Builds Cash to Cushion Bond Losses

Thursday, 16 Dec 2010 12:51 PM

The European Central Bank will almost double its capital base to help protect it from losses as the institution buys bonds of governments from Portugal to Ireland to fight the sovereign-debt crisis.

The Frankfurt-based central bank will boost its capital by 5 billion euros ($6.6 billion) to 10.76 billion euros, it said in a statement today. The change will take effect from Dec. 29.

The capital increase suggests the ECB is concerned that its program to buy bonds of strained governments, which now totals 72 billion euros, may saddle its balance sheet with losses. Policy makers have increased pressure on governments to do more to end Europe’s debt crisis on concern the ECB is shouldering too much of the burden.

“It’s clearly recognition that the ECB is getting concerned,” said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Plc in London. Still, “it’s a small amount and clearly not enough to offset the risk the central bank has taken on its balance sheet,”

The euro was little changed after the announcement and traded at $1.3241 as of 2:34 p.m. in London.

The money will come predominantly from the 16 national central banks which use the euro, and will be transferred in three equal annual tranches, the ECB said. The series of transactions will be completed by the end of 2012.

‘Increased Volatility’

“The capital increase was deemed appropriate in view of increased volatility in foreign-exchange rates, interest rates and gold prices as well as credit risk,” the ECB said. The increase “is also motivated by the need to provide an adequate capital base in a financial system that has grown considerably.”

The bond purchases could exceed the ECB’s level of reserves by the end of this year and a capital increase is “hardly surprising,” David Owen, chief economist at Jefferies International Ltd. in London, wrote in a note to investors yesterday. He said there is a risk the central bank may post a small loss this year, compared with a profit of 2.3 billion euros in 2009 and 1.8 billion euros the previous year.

Non-euro-area central banks will have to make “only minor adjustments” to their capital shares, the ECB said. The bank reduced the percentage of capital which central banks outside the currency region are required to pay as a contribution to ECB operating costs from 7 percent to 3.75 percent.

ECB Governing Council member Ewald Nowotny raised the issue of capital increases for national central banks last week.

“We are clearly seeing that risks are increasing in the system for European central banks because we are having to take on a whole range of extra risks,” Nowotny, who is also governor of Austria’s central bank, said on Dec. 10. “So in the whole European system we’ll have to get a better capital base for central banks.”

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