European Central Bank

European Central Bank

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European Central Bank
European Central Bank[show]
Logo of the European Central Bank European Central Bank headquarters
Logo of the European Central Bank European Central Bank headquarters
Headquarters Frankfurt am Main, Hesse, Germany
Coordinates 50.1095°N 8.6740°E
Established 1 June 1998
President Jean-Claude Trichet
Central bank of
Currency Euro
ISO 4217 Code EUR
€526bn in total[show]
Base borrowing rate 1.50%
Base deposit rate 0.75%
Preceded by
17 national banks[show]

The European Central Bank (ECB) is the institution of the European Union (EU) that administers the monetary policy of the 17 EU Eurozone member states. It is thus one of the world's most important central banks. The bank was established by the Treaty of Amsterdam in 1998, and is headquartered in Frankfurt, Germany. The current President of the ECB is Jean-Claude Trichet, former president of the Banque de France. Mario Draghi, currently governor of the Bank of Italy, is designated to succeed him when his term ends on 31 October 2011.[1]



[edit] History

Further information: History of the euro

The European Central Bank is the de facto successor of the European Monetary Institute (EMI). The EMI was established at the start of the second stage of the EU's Economic and Monetary Union (EMU) to handle the transitional issues of states adopting the euro and prepare for the creation of the ECB and European System of Central Banks (ESCB). The EMI itself took over from the earlier European Monetary Co-operation Fund (EMCF).[2]

Wim Duisenberg, first President of the ECB.

The ECB formally replaced the EMI on 1 June 1998 by virtue of the Treaty on European Union (TEU, Treaty of Maastricht), however it did not exercise its full powers until the introduction of the euro on 1 January 1999, signalling the third stage of EMU. The bank was the final institution needed for EMU, as outlined by the EMU reports of Pierre Werner and President Jacques Delors.[2] It was established on 1 June 1998.[3]

The first President of the Bank was Wim Duisenberg, the former president of the Dutch central bank and the European Monetary Institute. While Duisenberg had been the head of the EMI (taking over from Alexandre Lamfalussy of Belgium) just before the ECB came into existence, the French government wanted Jean-Claude Trichet, former head of the French central bank, to be the ECB's first president. The French argued that since the ECB was to be located in Germany, its President should be French. This was opposed by the German, Dutch and Belgian governments who saw Duisenberg as a guarantor of a strong euro.[4] Tensions were abated by a gentleman's agreement in which Duisenberg would stand down before the end of his mandate, to be replaced by Trichet, an event which occurred in November 2003.

There had also been tension over the ECB's Executive Board, with the United Kingdom demanding a seat even though it had not joined the Single Currency.[4] Under pressure from France, three seats were assigned to the largest members, France, Germany, and Italy; Spain also demanded and obtained a seat. Despite such a system of appointment the board asserted its independence early on in resisting calls for interest rates and future candidates to it.[4]

When the ECB was created, it covered a Eurozone of eleven members. Since then, Greece joined in January 2001, Slovenia in January 2007, Cyprus and Malta in January 2008, Slovakia in January 2009, and Estonia in January 2011, enlarging the bank's scope and the membership of its Governing Council.[2]

On 1 December 2009, the Treaty of Lisbon entered into force, ECB according to the article 13 of TEU, gained official status of an EU institution.

In April of 2011, the ECB raised interest rates for the first time since 2008 from 1% to 1.25% [5], with a further increase to 1.50% in July 2011 [6].

[edit] Powers and objectives

The primary objective of the ECB is to maintain price stability within the Eurozone, or in other words to keep inflation low. The Governing Council defined price stability as inflation (Harmonised Index of Consumer Prices) of below, but close to, 2%.[7] Unlike for example the United States Federal Reserve Bank, the ECB has only one primary objective with other objectives subordinate to it.

The key tasks of the ECB are to define and implement the monetary policy for the Eurozone, to conduct foreign exchange operations, to take care of the foreign reserves of the European System of Central Banks and promote smooth operation of the financial market infrastructure under the Target payments system[8] and being currently developed technical platform for settlement of securities in Europe (TARGET2 Securities). Furthermore, it has the exclusive right to authorise the issuance of euro banknotes. Member states can issue euro coins but the amount must be authorised by the ECB beforehand (upon the introduction of the euro, the ECB also had exclusive right to issue coins).[8]

In U.S. style central banking, liquidity is furnished to the economy primarily through the purchase of Treasury bonds by the Federal Reserve Bank. The Eurosystem uses a different method. Eligible banks, of which there are about 1500 may bid for short term repo contracts of two weeks' to three months' duration. [9] The banks in effect borrow cash and must pay it back; the short durations allow interest rates to be adjusted continually. When the repo notes come due the participating banks bid again. An increase in the quantity of notes offered at auction allows an increase in liquidity in the economy. A decrease has the contrary effect. The contracts are carried on the asset side of the European Central Bank's balance sheet and the resulting deposits in member banks are carried as a liability. In lay terms, the liability of the central bank is money, and an increase in deposits in member banks, carried as a liability by the central bank, means that more money has been put into the economy.[10]

To qualify for participation in the auctions, banks must be able to offer proof of appropriate collateral in the form of loans to other entities. These can be the public debt of member states, but a fairly wide range of private banking securities are also accepted.[11] The fairly stringent membership requirements for the European Union, especially with regard to sovereign debt as a percentage of each member state's gross domestic product, are designed to insure that assets offered to the bank as collateral are, at least in theory, all equally good, and all equally protected from the risk of inflation. The economic and financial crisis that began in 2008 has revealed some relative weaknesses in the sovereign debt of such member countries as Portugal, Ireland, Greece and Spain ('PIGS').[12] It is interesting that all four countries are located geographically on the periphery of the Eurozone. These securities are not limited to the countries of issue, but held in many cases by banks in other member states. To the extent that the banks authorized to borrow from the ECB have compromised collateral, their ability to borrow from the ECB—and thus the liquidity of the economic system—is impaired. This threat has drawn the ECB into rescue operations. But weak sovereign debt is not the only source of weakness in the ECB's operations, as the collapse of the market in U.S. dollar denominated collateralized debt obligations has also led to large scale interventions in cooperation with the Federal Reserve.

Rescue operations involving sovereign debt have included temporarily moving bad or weak assets off the balance sheets of the weak member banks into the balance sheets of the European Central Bank. Such action is viewed as monetization and can be seen as an inflationary threat, whereby the strong member countries of the ECB shoulder the burden of monetary expansion (and potential inflation) in order to save the weak member countries. Most central banks prefer to move weak assets off their balance sheets with some kind of agreement as to how the debt will continue to be serviced. This preference has typically led the ECB to argue that the weaker member countries must (a) allocate considerable national income to servicing debts and (b) scale back a wide range of national expenditures (such as education, infrastructure, and welfare transfer payments) in order to make their payments.

The European Central Bank had stepped up the buying of member nations debt.[13] In response to the crisis of 2010, some proposals have surfaced for a collective European bond issue that would allow the central bank to purchase a European version of U.S. Treasury Bills.[14][15] To make European sovereign debt assets more similar to a U.S. Treasury, a collective guarantee of the member states' solvency would be necessary.[16] But the German government has resisted this proposal, and other analyses indicate that "the sickness of the Euro" is due to the linkage between sovereign debt and failing national banking systems. If the European central bank were to deal directly with failing banking systems sovereign debt would not look as leveraged relative to national income in the financially weaker member states.[15]

On 9 May 2010, the 27 member states[17] of the European Union agreed to incorporate the European Financial Stability Facility (EFSF) a special purpose vehicle (SPV) off balance sheet of European Central Bank (ECB) placing bonds to raise money to financing the Deficit spending that European Governments used to replace a share of banking system losses. Even if, it is not legal under the European Union laws, the EFSF incorporation was mandatory because ECB cannot monetarize directly the European States' deficit spending. The main share of banking system losses (€ 3.5 trillions) are hidden into the main banks' balance sheets (and into the ECB's balance sheet). This fact give seriuos problems to liquidity of Interbank lending market involving trust that banks have each other and forcing ECB to use unconventional measures about Monetary policy.

On 17 December 2010, the ECB announced that it was going to double its capitalization.[18] (The ECB's most recent balance sheet before the announcement listed capital and reserves at €2.03 trillion.)[19] The sixteen central banks of the member states would transfer assets to the ledger of the ECB. In banking, assets (loans) are used to offset liabilities (deposits and currency). If some of the sovereign debt held as an asset by the ECB becomes non-performing, the asset is "bad" and the deposits, in this case, currency, are not appropriately backed. This inequality means that liabilities exceed assets and therefore the bank is in trouble. One response is to use the bank's capital to offset the losses. The use of capital to offset a loss transfers the loss to the bank's shareholders: the member banks. The increased capitalization of the ECB against potential sovereign debt default means that the sixteen member banks are also exposed to potential losses. In 2011, the European member states may need to raise as much as US$2 trillion in debt. Some of this will be new debt and some will be previous debt that is "rolled over" as older loans reach maturity. In either case, the ability to raise this money depends on the confidence of investors in the European financial system. The ability of the European Union to guarantee its members' sovereign debt obligations have direct implications for the core assets of the banking system that support the Euro.[18] Although "unthinkable," a collapse of the euro (with a reversion to individual national currencies) became, at the end of 2010, a topic of speculation in the financial press.[20]

The bank must also co-operate within the EU and internationally with third bodies and entities. Finally it contributes to maintaining a stable financial system and monitoring the banking sector.[21] The latter can be seen, for example, in the bank's intervention during the 2007 credit crisis when it loaned billions of euros to banks to stabilise the financial system.[22] In December 2007, the ECB decided in conjunction with the Federal Reserve under a program called Term auction facility to improve dollar liquidity in the eurozone and to stabilise the money market.[23]

[edit] Organization

Although the ECB is governed by European law directly and thus not by corporate law applying to private law companies, its set-up resembles that of a corporation in the sense that the ECB has shareholders and stock capital. Its capital is five billion euros[24] which is held by the national central banks of the member states as shareholders. The initial capital allocation key was determined in 1998 on the basis of the states' population and GDP,[25] but the key is adjustable.[26] Shares in the ECB are not transferable and cannot be used as collateral.[27]

All National Central Banks (NCBs) that own a share of the ECB capital stock as of 1 January 2011 are listed below. Non-Euro area NCBs are required to pay up only a very small percentage of their subscribed capital, which accounts for the different magnitudes of Euro area and Non-Euro area total paid-up capital.[28]

NCB Capital Key (%) Paid-up Capital (€)
Nationale Bank van België / Banque Nationale de Belgique 2.4256 180,157,051.35
Deutsche Bundesbank 18.9373 1,406,533,694.10
Eesti Pank 0.1790 13,294,901.14
Central Bank of Ireland 1.1107 82,495,232.91
Bank of Greece 1.9649 145,939,392.39
Banco de España 8.3040 616,764,575.51
Banque de France 14.2212 1,056,253,899.48
Banca d'Italia 12.4966 928,162,354.81
Central Bank of Cyprus 0.1369 10,167,999.81
Banque centrale du Luxembourg 0.1747 12,975,526.42
Bank Ċentrali ta' Malta 0.0632 4,694,065.65
De Nederlandsche Bank 3.9882 296,216,339.12
Oesterreichische Nationalbank 1.9417 144,216,254.37
Banco de Portugal 1.7504 130,007,792.98
Banka Slovenije 0.3288 24,421,025.10
Národná banka Slovenska 0.6934 51,501,030.43
Suomen Pankki - Finlands Bank 1.2539 93,131,153.81
Total 69.9705 5,196,932,289.36
Non-Euro area:

Българска народна банка (Bulgarian National Bank) 0.8686 3,505,013.50
Česká národní banka 1.4472 5,839,806.06
Danmarks Nationalbank 1.4835 5,986,285.44
Latvijas Banka 0.2837 1,144,798.91
Lietuvos bankas 0.4256 1,717,400.12
Magyar Nemzeti Bank 1.3856 5,591,234.99
Narodowy Bank Polski 4.8954 19,754,136.66
Banca Naţională a României 2.4645 9,944,860.44
Sveriges Riksbank 2.2582 9,112,389.47
Bank of England 14.5172 58,580,453.65
Total 30.0295 121,176,379.25
European Union
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The Executive Board is responsible for the implementation of monetary policy defined by the Governing Council and the day-to-day running of the bank. In this it can issue decisions to national central banks and may also exercise powers delegated to it by the Governing Council. It is composed of the President of the Bank (currently Jean-Claude Trichet), a vice president and four other members. They are all appointed by common accord of the Eurozone member states for non-renewable terms of eight years.

Jean-Claude Trichet, the current President.

The General Council is a body dealing with transitional issues of euro adoption, for example fixing the exchange rates of currencies being replaced by the euro (continuing the tasks of the former EMI). It will continue to exist until all EU member states adopt the euro, at which point it will be dissolved. It is composed of the President and Vice President together with the governors of all of the EU's national central banks.[29][30]

[edit] The crisis of 2011

This article or section may be slanted towards recent events. Please try to keep recent events in historical perspective. (September 2011)

Throughout 2011 various member states of the European Union showed themselves to be increasingly unable to meet financial commitments. At its heart, the crisis of the European currency unit or ECU is similar to almost any other financial crisis, including the crisis of 2008. Key concepts to understanding the crisis include collateral, assets, and liabilities.

The principal monetary policy tool of the European central bank is collateralized borrowing or repo agreements. These tools are also used by the United States Federal Reserve Bank, but the Fed does more direct purchasing of financial assets than its European counterpart. The collateral used by the ECB is typically high quality public and private sector debt. The criteria for determining "high quality" for public debt have been preconditions for membership in the European Union: total debt must not be too large in relation to Gross Domestic Product, for example, and deficits in any given year must not become too large. Though these criteria are fairly simple, but a number of accounting techniques may hide the underlying reality of fiscal solvency—or the lack of same. Furthermore, in a depressed economic environment tax revenues decline and alter the credit profile of states that have already issued debt.

In central banking, the privileged status of the central bank is that it can make as much money as it deems needed. In the United States Federal Reserve Bank, the Federal Reserve buys assets: typically, bonds issued by the Federal government. There is no limit on the bonds that it can buy. In the European Central Bank system, the central bank lends money on collateral put up by the official members of the banking system. There is no limit on the amount of collateral it can accept. Both operations have the effect of putting money into the economy, most of it in the form of electronic deposits. Additionally, the Federal Reserve can and does engage in collateral operations, and the European Central Bank can and does purchase assets outright rather than accept them as collateral.[31]

If bonds held by a central bank turn out to have lower value because the issuer is unable to pay, a basic principle of banking finance is violated: the liabilities of the bank (money used in the economy) are not properly balanced by assets held by the central bank (bonds owned outright, and also bonds held as collateral). In 2011 this is essentially what happened. The value of the assets (the bonds sold) by member states such as Greece, Portugal, Ireland, Spain, and eventually even Italy began to be discounted by international traders who questioned the ability of these states to meet their obligations under depressed economic conditions. As the market began to put lesser value on these assets, it diminished the value of assets held by the European Central Bank and also assets held by the private banks that do business with the European central bank.

There are a variety of possible responses to the problem of bad debts in a banking system. One is to induce debtors to make a greater effort to make good on their debts. With public debt this usually means getting governments to maintain debt payments while cutting back on other forms of expenditure. Such policies often involve cutting back on popular social programs.[32] Stringent policies with regard to social expenditures and employment in the state sector have led to riots and political protests in Greece.[33]Another response is to shift losses from the central bank to private investors who are asked to "share the pain" of partial defaults that take the form of rescheduling debt payments. However, if the debt rescheduling causes losses on loans held by European banks, it weakens the private banking system, which then puts pressure on the central bank to come to the aid of those banks. Private sector bond holders are an integral part of the public and private banking system. Another possible response is for wealthy member countries to guarantee or purchase the debt of countries that have defaulted or are likely to default. This alternative requires that the tax revenues and credit of the wealthy member countries be used to refinance the previous borrowing of the weaker member countries, and is politically controversial.[34] Indeed, reluctance in Germany to take on the burden of financing or guaranteeing the debts of weaker countries has led to public reports that some elites in Germany would prefer to see Greece, Portugal, and even Italy leave the Euro zone "temporarily."[35]

The ECB can attempt to absorb losses by raising capital from its members. The additional paid in capital is meant to offset the losses due to the poor payment prospects of the weaker members. Increasing the capitalization of the ECB by the wealthier states is another way of getting the wealthier states to pay for losses on debts issued by the poorer states, and therefore also controversial.

A central bank can ignore a balance sheet problem (either its own or member banks of the system that it governs) simply by listing its bad assets "at par value" (the original price) rather than acknowledging the actual market price, or, what amounts to the same thing, delaying enforcement.[36] Such a practice does not go unremarked by the international community: the reason that a government debt and banking crisis go together is in part due to the fact that the world's leading countries and their currencies are watched carefully for such balance sheet manipulations. Keeping weak assets on the books is a path to weakening the European currency against other international currencies. The reason that "doing nothing" in response to the collapse of member state public sector debt is not an option is that it would ultimately invite speculative attacks on the European currency and undermine its value.By early September 2011 a number of major European banks were technically insolvent: with significant Italian and Spanish bonds in their portfolios, the market mark-down of the value of these instruments left the banks with over-valued assets on their books. Banks in this condition are informally referred to as "zombie banks.[citation needed]"[37][not in citation given] Another sign of the crisis was that interbank lending was in retreat, with European banks having decreasing confidence in the solvency of other European banks.[37] A sharp decrease in inter-bank lending puts sharp constraints on the money supply and is a symptom of deepening crisis.

The ECB could, and through the late summer of 2011 did, purchase bonds issued by the weaker states even though it assumes, in doing so, the risk of a deteriorating balance sheet. ECB buying focused primarily on Spanish and Italian debt.[38] Certain techniques can minimize the impact. Purchases of Italian bonds by the central bank, for example, were intended to dampen international speculation and strengthen portfolios in the private sector and also the central bank.[39] The assumption is that speculative activity will decrease over time and the value of the assets increase. Such a move is similar to what the U.S. federal reserve did in buying subprime mortgages in the crisis of 2008, except in the European crisis, the purchases are of member state debt. The risk of such a move is that it could diminish the value of the currency. On the other hand, certain financial techniques can reduce the impact of such purchases on the currency. One is sterilization, wherein highly valued assets are sold at the same time that the weaker assets are purchased, which keeps the money supply neutral. Another technique is simply to accept the bad assets as long-term collateral (as opposed to short-term repo swaps) to be held until their market value stabilizes. This would imply, as a quid pro quo, adjustments in taxation and expenditure in the economies of the weaker states to improve the perceived value of the assets. In September 2011, Axel Weber and Jürgen Stark separately resigned before the ends of their terms from the Governing Council, both Germans thought to have been dissatisfied with the bank's bond-buying policy.[40] The resignations were reported as due to their opposition to potentially inflationary bond-buying programs conducted by the ECB. Subsequent declines in world stock markets were due in part to widespread concerns about the future of the Euro and the internal governance of the ECB.

Central bank debt purchases that are made to stabilize economic systems without regard to real economic growth are called monetization. Conventional theory argues that such increases in the money supply lead almost automatically to domestic inflation and to the currency's loss of value in international markets.[41] However, in conditions of economic crisis agents within the economy do not automatically increase spending and lending of additional available funds. Rather, the additional funds may sit idle in banks in a condition known as the liquidity trap.[42] However, banks with large idle funds are usually preferred to widespread defaults. In the case of Greece, some observers believe that if the ECB and European Union do not stabilize Greek debt and instead encourage the country to abandon the Euro, the result will be the collapse of the Greek banking system.[35] Such an outcome would potentially have major consequences for the future of the European Union.

The crisis of 2011 in the European currency and central banking system exposed the weaknesses inherent in a banking operation where the primary assets were issued by state entities that did not all have the will or the resources to make payments on what they had borrowed. Without a unified continental system of taxation, the credit-worthiness of the European Central Bank's balance sheet depends on a collection of member states with widely varying taxation systems and national economic characteristics.

By mid-August 2011 the flaws in the ECB and Euro design were becoming increasingly apparent. As bonds issued by the weaker members of the European Union collapsed in value, they dragged down the portfolios of bonds held by banks in the "strong" countries, especially France. Talks of strengthening the Euro included a plan whereby member governments would borrow from a central bond facility which all members would guarantee, but it was unclear how the tendency of weaker economies to borrow beyond their means could be controlled and still retain sovereignty, as reported in the Wall Street Journal:

Among potential steps debated in Europe is a system of centralized borrowings by all 17 members of the euro zone, with debt issued by an EU agency and every member vouching to stand behind the bonds used by its peers. Such euro bonds would dispel concerns Italy or Spain might not be able to get the financing they need, as it would be provided centrally. As a unit, the euro zone has relatively attractive fiscal prospects: Government deficit of 4.3% of gross domestic product is expected this year and debt of 88% of GDP. But euro bonds would come with a huge political cost. French President Nicolas Sarkozy on Tuesday rejected them, saying they would lead to strong countries being "in the position of guaranteeing debt they do not control.[43]

Although this crisis might seem to expose fundamental flaws in the design of the European currency and central banking system, the simultaneous political controversy over the debt ceiling in the United States showed that even a large nation with a unified economy and a unified system of taxation might not be able to honor its contractual debts because of political deadlock. In each case, what was (and remains) at stake was the value of the assets held in the central banking system that provides, as its chief liability and principal service to the economy, the circulating currency.

The European sovereign debt crisis has placed the ECB squarely in the center of major economic, financial, and social policy issues for the entirety of the European Union. Traditionally central banks prefer a low key public posture that is limited to occasional, and usually gradual, changes in the interest rate. Multiple international economic crises in the 2008-2011 period have pushed the ECB into the forefront as a core institution whose decisions will profoundly impact the economic, social, and political development of the European Union.

[edit] Independence and future

Furthermore, not only must the bank not seek influence, but EU institutions and national governments are bound by the treaties to respect the ECB's independence. For example, the minimum term of office for an national central bank governor is five years and members of the executive board have a non-renewable eight-year term.[44] To offer some accountability, the ECB is bound to publish reports on its activities and has to address its annual report to the European Parliament, the European Commission, the Council of the European Union and the European Council.[45] The European Parliament also gets to question and then issue its opinion on candidates to the executive board.[46]

The bank's independence has notably come under intense criticism since the election of Nicolas Sarkozy as French President. Sarkozy has sought to make the ECB more susceptible to political influence, to extend its mandate to focus on growth and job creation, and has frequently criticized the bank's policies on interest rates.[citation needed]

[edit] Location

Model of the ECB's new headquarters.

The bank is based in Frankfurt, the largest financial centre in the Eurozone. Its location in the city is fixed by the Amsterdam Treaty along with other major institutions.[47] In the city, the bank currently occupies Frankfurt's Eurotower until its purpose-built headquarters are built.[48]

In 1999 an international architectural competition was launched by the bank to design a new building. It was won by a Vienna-based architectural office named Coop Himmelbau. The building will be approximately 180 metres (591 ft) tall (the present building is 148 m/486 ft) and will be accompanied with other secondary buildings on a landscaped site on the site of the former wholesale market (Großmarkthalle) in the eastern part of Frankfurt am Main. The main construction began in October 2008, with completion scheduled during 2014.[49][50] It is expected that the building will become an architectural symbol for Europe and is designed to cope with double the number of staff who operate in the Eurotower.[48]