uploads/2015/01/capital-key1.png

ECB’s QE program demystified

By

Updated

A few quick points on the ECB QE: The central bank plans to purchase €60 billion a month of bonds with maturities ranging from 2 to 30 years until at least September of 2016. The size of the package, the open-ended nature of the commitment and the willingness to purchase longer dated bonds all came as positive surprises to investors, driving this past week’s strong equity rally.

Market Realist – 

Article continues below advertisement

ECB’s QE program – What is the extent of purchases?

The program will involve monthly purchases of 60 billion euro worth of securities by the ECB and the national central banks (or NCBs) of the 19-member Eurozone. The previously announced purchase programs of asset-backed securities and bonds would also come under the purview of this scheme. Existing programs have purchased 10 billion euro worth of securities each month. The program is slotted to begin in March and will last until at least the end of September 2016, though an extension could be granted if necessary. The 19-month program would thus amount to cumulative additional asset purchases of 1.114 trillion euro worth of assets.

ECB’s QE program – Who will buy how much?

The additional asset purchases of 950 billion euros would be split into two. 12%, or 114 billion euros, will include securities of European Institutions like the European Financial Stability Facility. 88%, or 836 billion euros, will include purchases of national sovereign bonds with maturities ranging between two to 30 years.

ECB's QE program  demystified - Capital key

8%, or 76 billion euros, of the additional asset purchases would be made by the ECB, out of which 9 billion euros would be on securities of European Institutions and 67 billion euros would be on national sovereign bonds. NCBs would make the remaining 92% of additional asset purchases (769 billion euros in national sovereign bonds and 105 billion euros in securities issued by European Institutions) in proportion of their capital key, or their share of fully paid up ECB capital. The capital key for the Eurozone can be seen in the previous graph.

ECB’s QE program – The risk sharing conundrum

If the bonds involved in the asset purchase program were to encounter trouble, how would the losses be shared? This is one problem that generated a great deal of debate. The ECB’s solution is the risks on the purchases of securities of European Institutions amounting to 12%, and the ECB’s purchases amounting to 8% will be on a fully risk-shared basis. The remaining 80% of potential risk would be assigned to individual NCBs. This means that if bonds that an NCB purchases were to default, the bank alone would be responsible.

The ECB’s QE program would prove to be beneficial for European equities and ETFs like the iShares MSCI EMU ETF (EZU), the SPDR EURO STOXX 50 ETF (FEZ), the Vanguard FTSE Europe ETF (VGK), the iShares S&P Europe 350 Index Fund (IEV), and the iShares MSCI EAFE (EFA).

Read on to the next part of the series to understand how ECB’s QE program came at a fortuitous time.

Advertisement

More From Market Realist