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Bank of Italy released the government debt statistics for June. As always a few entries are not quite up to date but they still allow for some important conclusions.

Table 5 includes monthly statistics by holding sector. ‘Resident MFIs’ increased their holdings during 2012 from €515,58bn in December 2011 to €607,69bn in May (+€92.11bn), ‘Other Resident Financial Institutions’ from €291,48bn to €315.21bn (+€23.73bn) and ‘Other Residents’ from €261.87bn to €333.91bn in April (+€72.04bn). It is clear that resident MFIs and other residents were the main drivers of the increase in resident holdings of Italian government debt. On the other hand, ‘Non Residents’ decreased their holdings from €739.51bn to €619.34bn in April (-€120.17bn or 16% of their holdings). In December 2011 residents held 61% of total government debt while in April the percentage increased to 68%, a change of more than 6% in 4 months time.

Overall, government debt increased by €75.06bn during the first half of 2012, compared with €58.76bn in the first half of 2011 and €55.74bn for the whole of 2011, an increase of more than 4.75% of GDP from 120.1% to 124.9% GDP. Given the fact that Italy is already in a deep recession (with quarterly GDP dropping 0.7-0.8% in 2012Q1 and Q2) government debt is on a path to quickly reach 130% of GDP (although around 6% will be held by Bank of Italy).

Based on OECD data, if this pattern of a loss of 0.7% of GDP quarterly continues, Italy will be back to 2001 GDP levels by the end of 2012 and pre-Euro in the mid-2013.

Bank of Spain released its balance sheet for May today. The basic observations are as follows:

  • Target2 liabilities continued to increase growing to €318.6bn, a change of €34bn in a month. On the other hand, the deposit facility dropped further to €36.8bn.
  • Lending from the ECB increased in May through the MROs (which closed at €9.2bn compared to €1.8bn in April) while the LTRO remained unchanged.
  • Government deposits dropped from their high level of €24bn to €11.2bn.

Overall it is clear that capital flight is steady at around €30bn/month. Spanish banks excess liquidity (acquired through the 3Y-LTROs) has dropped to alarming levels, while the MRO borrowing shows that the banking system is already facing liquidity problems. Furthermore, the government deposit position is now low and cannot function as a balancing factor.

If this level of capital flight continues in June as well, Spanish banks will need to use short-term MRO lending from the ECB to cover the liquidity leakage. Bank of Spain daily interbank rate statistics point to very limited and expensive (especially compared to eurepo rates) access to interbank lending and only in very short maturities (overnight for unsecured lending, one month for repo loans). The recent increases in MRO usage visible in ECB’s weekly statements might be a result of Spanish banks lending.

As far as the Spanish banking system is concerned, a third 3Y-LTRO is quite needed by now.

On the Italian front, Bank of Italy released data on Italian debt. Table 5 contains details of holdings of securities by sector:

Although the data does not contain the most recent monthly details for all categories it is quite evident that, especially after the 3Y-LTROs, domestic MFIs were the main buyers of government securities, coupled with other financial (Other residents did the same in the second half of 2011). On the other hand non residents continued their exodus from Italian debt which amounted to €95.8bn during 2011 and another €24.6bn in the start of 2012.

Unfortunately, data for non residents only reaches February but an extrapolation clearly shows that resident MFIs/financials probably only managed to match outflows from non residents. Judging from the recent increase in Italian yields they aren’t successful any more.

Overall, the data point to a stressed environment but they aren’t recent enough to draw clear conclusions.

Bank of Italy released its latest government debt statistics. Government debt holdings by sector are included on page 11. Stock numbers for June 2011 onwards are presented in the following table:

* Data refer only to securities (millions of €)

Its is quite evident that both Bank of Italy and domestic MFIs increased their holdings substantialy during 2011. Bank of Italy posted an additional increase of €10.8bn during the first two months of 2012 and domestic MFIs used LTRO funding substantialy by acquiring another €24.3bn of securities in January. Other residents did not change their holdings much, although there were some marginal swings up and down after August. On the other hand, foreigners were strong sellers of government debt securities, reducing their portfolio by more than €94bn during 2011 (unfortunately no data is available for 2012).

The following graphs depict changes more clearly, especially of the different paths for MFIs and other domestic financial institutions:


It seems that only the central bank and domestic banks support their government’s debt, with foreigners being very strongly risk averse and lowering their holdings by more than 10% in 6 months.

Bank of Italy March balance sheet was released today and it contains some very interesting data:

  • Banks increased their lending by EU75.2bn. The increase came from new LTRO lending of EU127.6bn, the retirement of a fine-tuning operation of almost EU47bn and a drop in MRO lending to the (negligible) amount of EU2.4bn (down from EU7.8bn). Total central bank credit of EU270bn is now a substantial percent of the Italian banks holdings of securities (EU860bn in February), even if Bank of Italy accepts collateral at par (which it does not). A large part of bank assets are now parked in ECB.
  • Net liabilities to the Eurosystem increased by the same amount (??) as central bank credit to EU270.4bn.
  • Although bank reserves (basically the deposit facility) increased by EU6bn, the change is attributed only to an equivalent decrease in the general government account.

What’s mostly troubling is the increase in Target2 liabilities. Unless Italian banks lent foreign Euro banks (which is doubtful, especially since loans would most probably be requested from high risk periphery banks), that means that LTRO net liquidity was effectively drained in just one month’s time. Apart from a different term structure on their loans, Italian banks are mostly back to their pre-LTRO position. Carry trade is now effectively over and this will probably be reflected on sovereign bond yields (and could explain the events of the last few days). Keeping an eye on Target2 numbers will also be important in order to verify that the increase in net liabilities was not due to loans to other European banks.

Another thing to keep an eye on in my opinion is usage of the MROs (which is available in the ECB weekly statement). If Italian (and other periphery) banks start to face liquidity constraints, that should translate to more MRO loans (which is equivalent to tightened monetary policy, since interest is paid at the end of the MRO).

Here are a few comments on ECB’s latest financial statement for the week ending at 16 March 2012:

  • Deposits related to margin calls dropped to nearly zero (a decrease of more than 17 billion €). This is clearly a very positive sign, highlighting the fact that the collateral posted by European banks to the ECB in its refinancing operations achieved a value close to the one during the loans inception. There was also a drop in the deposit facility which was offset by increased usage of the current accounts.
  • ECB’s lending to financial institutions increased by more than 31 billion €. The troubling fact was that 11 billion € came from increased use of the marginal lending facility (an overnight facility). Another 24.6 billion € are attributed to the latest MRO which came at 42 billion €, a number much larger than the recent MROs after the second LTRO. On the other hand, the ‘Other assets’ category dropped by 45,6 billion €. In it’s recent February balance sheet, the central bank of Italy had a fine-tuning (??) operation of 46.9 billion €, which was booked as ‘Other assets’ in ECB’s weekly statement. It seems that this operation probably ended this week and was replaced by increased short-term funding through the MRO and marginal lending facility, keeping total bank funding steady.

ECB’s weekly financial statement for March 2nd along with outstanding open market operations had some very interesting numbers, apart from confirming the fact that new net liquidity provided through the second 3-year LTRO was around 310 billion €.

First of all the last MRO dropped even further to 17.5 b€ from 29.5b€ a week before. A substantial 12 billion € decrease. By now MRO’s account for only 1,5% of total liquidity with most of it provided through 3 and 1 year LTRO’s, thus allowing averaging on the interbank lending rate which interestingly faces new lows every day.By now, ECB’s ability to steer interest rates has decreased since it would need to make substantial increases to its target rate in order to counter the averaging effect of over 1 trillion € in 3-year LTRO liquidity. Up to a point, ECB has taken an easing stance with its 2 LTRO’s.

A second and more worrying fact was the large increase (of 14b€) in ‘Deposits related to margin calls’. That means that, in just one week’s time, the market value of collateral posted to the ECB decreased by a significant percentage, pushing the lending banks to lower their effective lending (or in other words it had the end result of increasing the effective lending rate).

One of the most interesting facts was the increase of 46.6b€ in the ‘Other Assets’ category which matched an equivalent increase in bank deposits. Since ECB itself documents this category as ‘securities denominated in euro which are held outright by euro area central banks for investment purposes at their own risk’’, the increase highlights the fact that, even though ECB provided the banking system with more than 300 billion € of fresh liquidity, NCB’s still had to perform large actions.

Today’s Bank of Italy balance sheet for February shed some light on what actually happened. It seems that Bank of Italy decreased lending through MRO by 44.6b€, LTRO lending by 10b€ (which seems very strange since Italian banks should have taken the opportunity to borrow liquidity by using the relaxed collateral requirements) and made a ‘Fine-tuning reverse operation’ of 46.9b€ which seems to have been maintained till March 2 (otherwise it would not come up on ECB’s weekly statement). I don’t really see a reason for Bank of Italy to do that (especially since liabilities to the Eurosystem increased, indicating stress conditions which were only offset by a fall of the General Government account balance), one guess is that it lent out at its own risk. requiring even lower quality collateral.

Going through ECB’s financial statements will be interesting during the following weeks.

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Kostas Kalevras

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