Banks, the ECB, and Bonds

Via IFR

Under the ECB’s new long-term refinancing operations starting on December 21, banks will be allowed to borrow money against certain assets on a three-year basis, paying just 1% per annum. They could then buy Italian 10-year bonds yielding more than 7%, and pocket the difference.

But rather than use money raised via the ECB to buy government bonds, bankers say that they are more likely to use the funds to pay off their own debts.

“I can’t think for a moment why anyone would want to [buy eurozone government debt],” said the head of capital markets at one European bank that is also reducing its exposure to eurozone sovereign bonds. “Everyone is trying to protect capital. It’s counter-intuitive. It would be digging a deeper hole for yourself.”

The theory, as explained above, is that banks buy sovereign bonds at whatever the going rate is, and park these bonds at the ECB at 1%, pocketing the difference.  The banks get to keep the difference (yay! free money!), and the countries get their bonds sold, and the ECB doesnt (theoretically) buy the sovereign bonds.
The problem (not explained above) is that the banks have to mark their assets at the ECB to market, which removes the whole benefit from the above exercise.  To translate

• The bank buys Italian bonds at 6% (for example)
• The bank parks it at the ECB paying 1%
• However, the secondary market has the Italian bonds at 6% too (or worse).
• So, the bank now needs to mark down their bond by 6%.
• Which means that instead of making 6 - 1 %, they are actually making (6 - 6) - 1%, i.e, -1%.
• And, the banks already have capital shortfalls

No wonder the banks are not interested.  They'd be dumb to do this...