FRANKFURT (MNI) – New financial market regulation requiring higher
capital levels means that the shift from unsecured towards secured money
market lending may be a permanent phenomenon, the European Central Bank
said in its Euro money market study released Tuesday.

In 2010, borrowing on the unsecured market fell by 22%, the report
said. “The results of the survey show that the decline in turnover in
the unsecured market was mirrored by an increase in secured market
turnover,” the ECB said.

A “major factor” explaining this shift is the unlimited liquidity
offered by the ECB in its open market operations, resulting in abundant
surplus of liquidity as well as more risk aversion, the report said.

However, the changed capital and liquidity rules suggest that a
post-crisis demand for secured lending will continue to exceed
pre-crisis levels even after the crisis-spurred extra liquidity support
expires, the ECB suggested.

“The emphasis placed by regulators and banks on capital
preservation after the crisis also means that unsecured lending, which
is more capital-absorbing than other activities, tends to be avoided by
banks in favour of other kinds of lending (e.g. secured lending) with
lower risk. This is particularly true for unsecured lending with longer
maturities,” the central bank said.

Liquidity regulations may also have had an impact on turnover in
the unsecured market, the report said.

“Some banks, for example, reported that liquidity regulations which
require them to hold large liquidity buffers help explain the decline in
the amount of unsecured lending for overnight maturities. The reason is
that a large part of their liquidity buffers is made up of cash they
deposit overnight with central banks which they no longer lend out to
the market, the report said.

Prior to today’s report, some ECB policy-makers had already
indicated that there may be a permanent shift towards more secured
lending. “New rules are likely to impact on the markets for liquidity
and on the demand for central bank refinancing,” Executive Board member
Lorenzo Bini Smaghi said in a speech on Basel III and monetary policy.

Today’s report, which is largely backward looking, warned that “to
the extent that financial market conditions indicate that extraordinary
liquidity measures may no longer be needed to safeguard a smooth
implementation and transmission of monetary policy, and no significant
market segmentation exists,” maintaining unlimited liquidity supply
would “distort overall functioning of money markets.”

You can find the full report on the ECB’s website:

http://www.ecb.int/home/html/index.en.html

–Frankfurt bureau; +49-69-720142, jtreeck@marketnews.com

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