MNI INTERVIEW: ECB May Buy Bank Loans In QE:Ex Market Ops Head

By Silvia Marchetti

     ROME (MNI) - The European Central Bank could turn to purchasing bank loans

when its quantitative easing programme hits limits on buying government debt, a

former director general of the ECB's markets operations department told MNI.

     Some E400 billion in bank loans, out of the eurozone's total of more than

E9 trillion, are eligible as guarantees against ECB refinancing operations, and

these could be tapped once the central bank's sovereign bond holdings bump up

against the 33% ceiling on issuers' outstanding securities, said Francesco

Papadia, who ran ECB market operations from 1998 to 2012.

     "This would be the most natural new class of assets that it could add to

its purchases," said Papadia, now chair of the Selection Panel of the Hellenic

Financial Stability Fund, "Bank loans are the only assets eligible for

refinancing operations that the ECB has not purchased so far."

     Loans would be selected according to risk and size, he said.

     "Loans extended to clients would not raise credit risk for the ECB towards

banks, for it would be purchasing client credit and not bank credit."

     The ECB, which reinitiated QE at a E20-billion-a-month pace Nov. 1, may

find itself struggling to continue purchasing government debt within 6-12

months, when it could find itself owning a third of German bunds, Papadia said.

     --NO CONFLICT OF INTEREST

     "Purchasing loans extended by banks to their clients would establish a

direct link to the real economy and avert the potential conflict of interest for

the ECB as bank supervisor that would arise if the ECB would purchase bank

bonds," said Papadia.

     The central bank may eventually be able to raise issuer limits closer to

40%, Papadia said. But he added that such a move would require time and careful

consideration, and that in the meantime the ECB may be more likely to cut rates

further than to expand QE beyond E20 billion a month in the face of an economic

downturn, given the opposition within its Governing Council to September's

announcement of fresh asset purchases.

     The ECB's deposit rate, currently at -0.5%, could feasibly be cut as low as

-1%, according to Papadia, but he warned that keeping rates below zero for a

prolonged period could bring unwanted side-effects.

     "A further rate cut can't be ruled out, but the point is would it actually

be effective to further cut the interest rate by another 10 basis points, as per

market expectations? I am afraid rate cuts can now have little effect, even if

probably we haven't yet reached the reversal rate point whereby the negative

effects outweigh the positive ones," he said, adding it was hard to determine

where exactly that rate was.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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