Another milestone has been reached in European Central Bank history.
Following last week’s three-year longer-term refinancing operation, the size of the ECB’s balance sheet has exceeded €3trn for the first time (ECB, in this context, actually means “eurosystem” — the network of eurozone central banks of which the ECB is part). Its latest financial statement shows a €330.6bn increase in assets compared with last week, which was more or less the same as the increase in lending to eurozone banks.
As such, the ECB has drawn further ahead of the Federal Reserve in terms of the overall size of its balance sheet (see chart below).
According to the Money Supply’s calculations, the point at which the ECB overtook the Fed was around last August – when the eurozone debt crisis started to escalate. But the effects of the two three-year LTROs sent the figures soaring.
No doubt, the latest figures will add to the nervousness at the Bundesbank, which has raised concerns about the risks entailed in such a dramatic balance sheet expansion – and longer term dangers of a banking system which has become dependent on central bank funds. On the liabilities side, the effects of last week’s LTRO shows up in an increase in the funds deposited in the ECB’s overnight deposit facility.
But it may be some comfort to look, not at the absolute size of the ECB balance sheet, but its size relative to mid-2006 levels.
“Other central banks have sized up their balance sheets at a faster pace,”
says Nick Matthews, European economist at Royal Bank of Scotland. He notes that the latest ECB balance sheet size is 2.8 times greater than the mid-2006 level, when it was way above the size of the Fed’s at the time. Over the same period, the Fed’s balance sheet expanded 3.4 times, and the Bank of England’s 3.9 times.
The hope in Frankfurt is that the ECB balance sheet size has reached a peak. The assumption is that there will be no more three-year LTROs. And if eurozone financial market conditions continue to improve, the ECB’s 23-strong governing council will start preparing an “exit strategy” – the Bundesbank is already lobbying for a reversal of recent rule changes that allowed banks to use a broader
range of assets as collateral when obtaining ECB liquidity. That would see demand for ECB loans falling.
But that assumes the good news continues. A re-escalation of the eurozone debt crisis could force the ECB to expand its balance sheet even further.