ECB’s new capital key to have virtually no repercussions

On 1 January 2019, the key for the ECB’s capital subscription is set to be changed. The ECB adjusts the capital shares of the national central banks (NCBs) at least once every five years, and always when a new country joins the European Union (EU). The last change to the ECB’s capital key was effected on 1 January 2014. This process involves the individual NCB shares in the capital of the ECB being weighted in equal proportions to member states’ shares of the EU’s overall population and gross domestic product. Based on the latest Eurostat data from 2017, major changes will occur this time around in respect of Italy and Germany. Whereas Germany’s capital share should rise by some 0.7 percentage points, Italy’s share is set to fall by around 0.9 percentage points. This would mean a decline in ECB demand for Italian government bonds in the context of the Asset Purchase Programme (APP) from 2019 onward.

For the bond-buying initiative known as the Public Sector Purchase Programme (PSPP), both new purchases of government bonds and the reinvestment of bonds maturing must be distributed proportionately in keeping with the ECB’s capital key. Germany accounts for the largest share of this key, namely 25.6%. In actual fact, the ECB deviates significantly from the capital key in its PSPP purchases. The greatest deviation can be seen in the case of Portugal – the ECB’s holding of Portuguese public sector securities is currently some 24% below the target figure prescribed by the capital key. In addition, it remains unclear quite how the ECB will implement the adjustment of its capital key at the year-end from a technical perspective. A decision on this issue is likely to be made at the meeting of 13 December. ECB President Draghi has already stressed on a number of occasions that the capital key will also act as an “anchor” during the reinvestment phase.

There is every reason to believe that the ECB will only apply the new capital key to reinvestments, and not to already purchased PSPP holdings. Any application to existing PSPP holdings would involve significant portfolio switching and therefore harbors potential for market disruption, which is not something the ECB is or should be seeking. And it is also a given that the actual distribution of PSPP holdings will still deviate significantly from the capital key even after application of the new key – so the problem will remain unresolved. Above all, portfolio switching could be avoided if the ECB chooses to only apply the adjusted capital key to reinvestments. The PSPP portfolio would then gradually align itself with the new key over the medium to long term.

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