In the aftermath of the ECB’s QE announcement one topic has received far less attention than it should: the unexpected collapse of risk-sharing across the Eurosystem as a precursor to QE. This is what prompted “gold-expert” Willem Buiter of Citigroup to pen an analysis titled “The Euro Area: Monetary Union or System of Currency Boards”, in which he answers two simple yet suddenly very critical for the Eurozone questions: which “currency boards”, aka national central banks, are suddenly most at risk of going insolvent, and should the worst case scenario take place, and one or more NCBs go insolvent what happens then?
First, this is how Buiter calcualtes the loss absorption capacity of individual National Central Banks. In other words, the country whose central bank has the smallest OBLAC number is the one which go under first once the ECB looses control.
Note that the ECB, and the NCBs of the Eurosystem live in a world of their own as regards accounting standards, statutory capital requirements etc. There is, as a matter of fact, no statutory capital requirement for the ECB. NCBs tend to have (national) statutory capital requirements. Neither the ECB, nor the NCBs follow the IFRS accounting standards or the IPSAS accounting standards.14 The Governing Council of the ECB has the statutory power to set harmonized accounting standards and principles for all euro area NCBs, making it easier for the ECB to determine whether an NCB is meeting its commitment to do all it can, within the constraints of the NCB’s total resources, to keep the ECB adequately capitalised.
We conclude that NCB insolvency, even under the generous ‘no negative CLAC’ definition of solvency, is a risk for a number of Eurozone NCBs. The risk is clearly greater if Revaluation Accounts are excludeed from the definition of unconditional (conventional) loss absorbing capacity. It is a material risk if downward revisions of future potential output growth in the euro area lead to a downward revision of the NPV of future seigniorage revenues (the estimates in Figure 7 are based on the assumption of 1% p.a. real GDP growth for all time in the future).
Here is Buiter on the question of “What happens if an NCB goes bust?”
What happens to an NCB in the Eurosystem that has negative CLAC? There are four possibilities:
- The NCB may get recapitalized by its own sovereign.
- It may get bailed out by other entities.
- The debt issued the NCB gets restructured but it retains access to Target 2 for future funding.
- It may lose the ability to transact with the rest of the Eurosystem.
Full article: Which European National Central Bank Is Most Likley To Become Insolvent, And What Happens Then? (Zero Hedge)