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This pathway will walk us through the basics of banks, starting with some of the different types and their main functions, then starting to look at the regulation faced by the banks, both before and after the Global Financial Crisis.

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Greenwashing is the act of distributing false information about something being more environmentally friendly than it actually is.

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Tackling the Cost of Living Crisis

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CSR and Sustainability in Financial Services

In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

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Banking Essentials - Part I

This pathway will walk us through the basics of banks, starting with some of the different types and their main functions, then starting to look at the regulation faced by the banks, both before and after the Global Financial Crisis.

Greenwashing

Greenwashing is the act of distributing false information about something being more environmentally friendly than it actually is.

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Connect Finance Unlocked to your current platform

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Tackling the Cost of Living Crisis

In this video, Max discusses the cost-of-living crisis currently enveloping the UK. He examines its impact on households as well as the overall economy.

CSR and Sustainability in Financial Services

In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

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Covered Bonds and Central Banks

Covered Bonds and Central Banks

Richard Kemmish

30 years: Capital markets & covered bonds

Central banks are some of the most important players in the covered bond market. In this video, Richard looks at three of those ways: as investors, as repo counterparties and via quantitative easing programmes.

Central banks are some of the most important players in the covered bond market. In this video, Richard looks at three of those ways: as investors, as repo counterparties and via quantitative easing programmes.

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Covered Bonds and Central Banks

7 mins 24 secs

Key learning objectives:

  • Discuss the Central Banks involvement in the covered bond market as investors, as repo counterparties and via their QE programmes

  • Explain the disadvantages of the previous programmes

  • Identify the ECB’s criteria and rules for purchasing and holding covered bonds

Overview:

Central Banks, most notably the European Central Bank, has three key roles in the covered bond market. The first is acting as investors. Secondly, as repo counterparties and lastly via their quantitative easing and asset purchasing programmes.

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Summary

What were the ECB’s asset-purchase programmes, and were they successful?

  1. The first programme (July 2009 - July 2010) – The ECB bought 60bn euros of covered bonds. The intention was to help the covered bond market recover from the financial crisis and provide a funding lifeline to banks to stimulate lending to the real economy.
  2. The second programme (late 2011 - 2012) – It was designed to be similar but smaller to the first with a target size of 40bn euros. However, it became apparent it was unnecessary and counterproductive as the market recovered quickly. It was abandoned after 16bn was bought.
  3. The third programme (2014) – Its intention was not to help the covered bond market, but it was part of a much broader programme of quantitative easing. The target size was 262bn euros.

What were the disadvantages that arose as a result of these programmes?

Many investors were ‘squeezed out’ by the ECB’s buying. Also, credit spreads in covered bonds compressed to levels that were unsustainably narrow for most investors and liquidity was severely damaged by the ECB’s policy of buying most of the bonds in the secondary market.

What is the ECB’s eligibility criteria for their purchases?

  • They have to be issued from a bank in the euro area
  • They must be rated investment grade
  • They must be eligible for repo treatment
  • They must be denominated in euros

What are some additional rules that the ECB has set regarding bonds?

  • Limiting itself to holding a maximum of 70% of any one bond
  • Bonds can be purchased in the secondary market or at the new issue
  • No longer any restrictions on the maturity of the bonds
  • No longer any restrictions on the maximum size of bonds

What is the ECB’s involvement in the CBM as repo-counterparties?

Central Banks provide liquidity to the banking system by lending money against high-quality collateral (covered bonds) in repo agreements. In practice, anything from 10% to 33% of the total advances to banks, provided by the ECB, are secured on covered bonds.

How does the ECB’s eligibility categories tell us how much a bank can borrow against bonds?

The ECB divides eligible collateral into different categories (1-5) with 1 being the best assets. Covered bonds are included in categories 2, with a notional size of 500mn euros or category 3 <500mn. For example, if they use a double A rated 5-year covered bond in C2 as collateral, a bank can borrow up to 97.5% of its market value.

How is the Central Bank involved in the CBM as investors?

Sometimes Central Banks and sovereign wealth funds just buy covered bonds as part of their own investment programmes. The Chinese State Administration for Foreign Exchange and Norges Bank have been very large players in this market in their own right.

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Richard Kemmish

Richard Kemmish

Richard is a consultant working mainly in the covered bond market. He helps Finance Ministries and Central Banks in countries without covered bond laws to put legal frameworks in place. He has also helped the European Commission with their legislative agenda for covered bonds and related products.

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