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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7 mins 24 secs
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.
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
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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.
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.
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.
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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