Note: For context, you may want to first read this article: What happens when banks fail?

Throughout the early 2010s, as Europe, and the world at that, was still licking the wounds it carried with it from the global debt crisis, a decision had to be made on how the bloc will approach future liquidity crises. The road chosen was the one that led away from 2008. And quite directly so – Whereas that crisis would lead to a stream of bailouts that left a deep crater in the public funds used to execute them – this ‘new’ path, probably best manifested by the 2015 Bank Recovery and Resolution Directive, would introduce a rather conveniently named ‘Bail-in’ tool, wherein banks recapitalised and absorbed losses from within. This means that instead of dipping into billions in taxpayer funds, a bank’s debt is reduced by the value of its shares, bonds, and uninsured deposits – with shareholders and depositors taking the damage instead. 

Emergency Liquidity Assistance, commonly known as “ELA”, is, as its name suggests, a type of emergency financial support provided by the national central banks within the Eurosystem to banks in need. This assistance is designed specifically for banks that are fundamentally sound and crucially, solvent, but are experiencing short-term cash flow issues. Banks eligible for ELA are generally in a situation where they can’t get the cash they need from other banks through the usual interbank lending methods, nor can they access funds through the standard monetary policy operations managed by the European Central Bank. In simpler terms, ELA acts as a temporary financial lifeline for these banks, helping them stay afloat during their liquidity crisis.

The “Eurosystem” refers to the European Central Bank and the national central banks of the Member States whose currency is the euro, collectively.

It is vital to note here, that while the ECB plays a significant role in ELA procedures, the primary responsibility for providing ELA rests with the national central banks (NCBs) within the Eurosystem. This means that it’s up to each NCB to decide whether or not to offer this kind of support. They have the authority to independently determine if they will provide central bank liquidity to solvent credit institutions. The only, or at least one of the biggest ‘golden rules’ they must observe – is the monetary financing prohibition set out in the Treaty governing the Eurosystem. This rule prevents central banks from directly financing governments, ensuring that when they provide ELA, it is strictly for short-term liquidity support to banks and not for funding government deficits. In summary, while national central banks have significant flexibility in offering ELA, they must do so within the framework of broader European regulations.

Therefore, a bank cannot assume that ELA will be available to it. It is also undisputed that apart from the solvency requirement we mentioned, ELA can only be granted when it is secured by “sufficient” collateral. Here we see a perfect example of what is meant by ‘discretion with limits’ – in this case, there is a set rule that sufficient collateral is necessary for the provision of ELA. Thus, the NCB has discretion in designing the applicable collateral framework, but at the end of the day must always ensure that “sufficient’ collateral” is pledged. As can be inferred from the ELA agreement (the document issued by the ECB that sets out the rules and procedures related to ELA), collateral is deemed “sufficient” for ELA if the asset is both eligible for ELA and its ‘post-haircut value’ is greater than or equal to the amount of ELA disbursed, including interest.

A “haircut” is the amount by which the effective value of the asset used as collateral is reduced to reflect the credit rating and other risk factors that may impact its value. How much of the beer glass is still full once the froth is removed – if that makes any sense.

In terms of procedure, the assessment of assets offered as collateral is a cooperative process between the bank seeking ELA and the NCB. The bank must give the NCB detailed information on the potential collateral to allow the NCB to determine the eligibility of the assets as collateral and the collateral’s effective value in ELA operations by applying the relevant haircuts.

Following this assessment, the bank must satisfy the legal requirements to pledge the assets. Under recent versions of ELA agreements, NCBs must report their decision to provide ELA, along with information relating to the applicable terms and conditions, to the ECB within two days after the operation is carried out, where it involves up to €500 million in ELA, and in advance of the operation or limit, where it involves a higher amount. The ECB may veto ELA if it determines, by a two-third majority of its Governing Council, that the provision of ELA would interfere with the objectives and tasks of the Eurosystem, including the single monetary policy and the prohibition against monetary financing.

If the ELA amount exceeds €2 billion, the NCB must seek the ECB Governing Council’s Non-Objection to the ELA operation. During the proceedings of an international arbitration following a bank resolution, Spain provided the following step-by-step presentation of the ELA process.

STEP 1: ELA Request

The bank requests an amount of ELA to their NCB

STEP 2: Solvency Assessment

In the case of a bank that is supervised directly by the ECB, the NCB requests the ECB to assess the liquidity and solvency position of the bank to grant ELA

STEP 3: Identification of Potential Collateral

The bank identifies for the NCB the assets it intends to use as collateral to secure the requested amount of ELA.

STEP 4: Determination of Haircuts and Maximum Amount of Potential ELA

Based on the information supplied by the bank, the NCB calculates, per the ELA Principles, the applicable haircuts and the maximum amount of ELA that can be supported by the assets identified by the bank as potential collateral.

STEP 5: Non-Objection

If the estimate of the maximum amount of ELA that could potentially be provided to the bank exceeds €2 billion, the NCB must request the ECB’s non-objection to the provision of that ELA.

STEP 6: ELA Contract

Provided the ECB grants its non-objection, where applicable, the NCB and the bank enter into an ELA contract, which provides for the terms and conditions of the ELA, including the requirement to pledge sufficient collateral in favour of the NCB to secure the amount of ELA sought.

STEP 7: Pledging the Collateral

The bank pledges the relevant assets as collateral in favour of the NCB under EU and national law and the contractual framework.

STEP 8: Disbursement Request

The bank makes a disbursement request for an amount that is backed by the collateral pledged in favour of the NCB, and up to the maximum amount of ELA authorised, according to the provisions of the ELA contract.

STEP 9: ELA Disbursement

The NCB disburses the corresponding amounts of ELA requested based on and supported by the assets the bank has pledged in favour of the NCB.

The views expressed in this article are those of the author/s and do not necessarily represent a position or perspective of this or any organisation