Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Siemens and the ECB

There have been a number of press reports about the German engineering giant Siemens parking € 4-6 billion of cash with the European Central Bank (ECB) in the form of one week deposits instead of leaving it with commercial banks (see, for example, here, here and here). Much of the commentary has emphasized the flight to safety motive for this move, but the reports also point out that the ECB pays a slightly higher interest rate on one week deposits than what the banks offer on longer term deposits. Assuming some tolerance for interest rate risk (the ECB rate could fall in future!), the move could also be justified purely as a pursuit of returns.

I would however like to ask the ultimate tail risk question (to which I have no answers) – is it reasonable to assume that there is no risk in depositing money with the ECB? The best analysis of the ECB’s solvency that I have seen is a piece by William Buiter written a couple of years ago (at his maverecon blog at the Financial Times several months before joining Citigroup as its Chief Economist). Much of the data in this is a little dated, but the analysis is illuminating all the same.

In his piece (entitled “Does the ECB/Eurosystem have enough capital?”), Buiter pointed out that the ECB has a leverage of 70:1 and even the consolidated balance sheet of the ECB and the Eurozone national central banks showed a leverage of 25:1. Buiter also noted that the asset side of the ECB balance sheet “includes a lot of rubbish”. And that was before it had started buying peripheral sovereign debt in a big way. Yet, Buiter concluded that all this “would not endanger the solvency of the Eurosystem, which has the present discounted value of current and future seigniorage income (the interest earned (or saved) by being able to borrow at a zero rate of interest through the issuance of currency and through mandatory reserve requirements).” Those who want a more elaborate theoretical treatment of seigniorage would find it useful to read his 2007 academic paper on the subject.

Buiter estimated that the capitalized value of the current and future stream of seigniorage would be 20 percent of Euro Area annual GDP. This capitalized value of seigniorage was according to Buiter sufficient to mark all the assets on the ECB’s entire balance sheet all the way down to zero and still leave it economically solvent.

One cannot ask for a more conclusive affirmation of solvency than this. But my question was about tail risk, and a tail risk scenario would include a possible euro zone break up. In that scenario, would the seigniorage income flow to the ECB or to the national central banks? And would those national central banks stand behind the ECB?


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