Weber Says ECB Must Ensure Banks Don't `Abuse' Rules

By Andreas Scholz and Simon Kennedy

Aug. 27 (Bloomberg) -- The European Central Bank must ensure cash-strapped financial institutions don't take advantage of its money-market auctions, council member Axel Weber said.

``We are monitoring banks' use of the collateral framework very closely,'' Weber, who heads Germany's Bundesbank, said in an interview in Frankfurt yesterday. ``We must ensure that our framework is not abused.''

The ECB will soon announce changes to the rules governing its auctions, council member Yves Mersch said in an Aug. 23 interview. The growing concern of officials is that banks struggling to sell securities damaged by the credit-market turmoil will dump them on the ECB and become overly reliant on central-bank funds.

``The collateral that we take must also be traded in the market because only then is it priced accurately,'' Weber said. ``We aim at taking final decisions in autumn which will be communicated immediately.''

The ECB's Governing Council next meets on Sept. 4.

Banks with operations in the 15 countries sharing the euro can raise funding from the ECB by pledging certain types of collateral including asset-backed securities. Bonds backed by mortgages and other assets accounted for 18 percent of the ECB's loan collateral at the end of 2007, up from 4 percent in 2004, Fitch Ratings data show.

The ECB lends to banks mostly through the main refinancing operations maturing in one week. Longer-term auctions provide financing to banks during three- and six-month periods.

Governing council member Michael Bonello said in an interview with Reuters published today that he didn't expect ``major fundamental change.''

`Funding Opportunities'

Spain's banks in particular are struggling to attract investors as a decade-long property boom ends and mortgage delinquencies soar to the highest in at least six years. Investors demand higher rewards to buy bonds backed by Spanish mortgages than any other home loans in Europe. The ECB lent Spanish banks a record 49.4 billion euros ($73.1 billion) in July.

The ECB's money-market system is also attracting demand from outside the euro region. The Frankfurt-based central bank said in June it will accept asset-backed bonds sold by Macquarie Group Ltd., Australia's biggest securities firm, and backed by Australian consumer loans as collateral. U.K. mortgage lender Nationwide Building Society said Aug. 18 it's planning to expand into Ireland, a member of the euro region, to take advantage of ``funding opportunities.''

`React Quickly'

Weber defended the ECB's approach to date, saying the fact it had the widest collateral framework among major central banks ``helped us to react quickly when the financial crisis broke out.'' The task is now to carry out the central bank's routine two-year review of its collateral framework, he said.

Former Bank of England policy maker Willem H. Buiter says the ECB may be assigning unrealistically high prices to the debt it accepts as collateral for bank borrowing, which risks delaying the recovery of the mortgage-backed bond market.

``There is almost certainly an overpricing of the bonds,'' Buiter, now a professor at the London School of Economics, said in a telephone interview yesterday. ``By artificially supporting the market the ECB may be crowding out private purchasers.''

Mersch said last week that there will be no ``broad-based revolution'' and that changes to the collateral framework would be unveiled within weeks.

``At the margins there can still be cases where you see dangers of gaming the system,'' Mersch said in Jackson Hole, Wyoming. ``The Governing Council has been discussing the whole issue'' and has agreed on a ``certain amount'' of refinement to the existing rules, he said.

``We certainly won't tolerate the creation of collateral for central banks only without the intention of trading them,'' Weber said.

To contact the reporters on this story: Andreas Scholz in Frankfurt at agscholz@bloomberg.net; Simon Kennedy in Paris at Skennedy4@bloomberg.net