Money markets ecb repayment raises counterparty, collateral questions

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* ECB cash repayment raises concerns* 11 bln euros of LTRO money returned* Questions over collateral/counterpartiesBy Kirsten DonovanLONDON, May 11 An early repayment of 11 billion euros of low cost funding to the ECB last week may be due to a bank losing its eligibility as a counterparty or a shortage of collateral, underscoring concerns about the general health of the banking sector. The European Central Bank's weekly financial statement showed that 10.8 billion euros ($14 billion) of longer-term refinancing operations (LTROs) were repaid last week before maturity. This is unusual because banks are not permitted to repay such funds early. There are exceptions for the December and February three-year funding operations but even those officially cannot be repaid before one year has passed.

The outstanding amount on December's 489 billion euro three-year operation has fallen to 481 billion euros as of Thursday, although Commerzbank calculates that only around 6 billion euros of this was repaid this week. The rest of the money that was repaid early was borrowed at other long-term ECB operations."When pledged collateral becomes ineligible and the counterparty cannot come up with a replacement ... cash out of the open market operations has to be paid back," said Commerzbank rate strategist Benjamin Schroeder in a research note.

"A case where an institution itself loses its status as ECB counterparty is also conceivable."According to the ECB's website, the central bank's counterparty eligibility criteria include being subject to the Eurosystem's minimum reserve system and being "financially sound". If a financial institution is no longer eligible to borrow from the ECB it would have to reimburse any funds that it had borrowed.

"It does raise a concern as having 11 billion euros of LTRO money would suggest you're not a small bank," said one analyst who declined to be named. Commercial bank borrowing from the ECB has been high in countries most affected by the sovereign debt crisis for many months as many institutions have found funding markets firmly closed. After the second of the ECB's three-year financing operations, Spanish banks accounted for 27 percent of all ECB funding and Italian banks 23 percent."If the (repayment to the ECB) relates to a single bank, the sheer amount points to a larger dependency on the ECB," said Commerzbank's Schroeder.