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10 15 2015 | by Victor Xing | Central Banks

Does the European Central Bank replace the functions of Eurozone national central banks?

The European Central Bank (ECB) did replace national central banks of the 19 euro area countries in formulating and overseeing implementations of monetary policy.  However, these national central banks still exist, and they still perform critical functions on behalf of the ECB and for their respective economies.

European Central Bank’s decision-making body

The Governing Council is ECB’s main decision-making body.  It consists of a 6 member Executive Board, as well as Governors of the 19 national central banks.  Everyone is equal, but some are more equal than the others.  In this case, opinions by members of the Executive Board carry more weight.

This 25 member group sets ECB’s key interest rates

  1. Deposit facility rate at -0.20%
  2. Refinancing rate at 0.05%
  3. Marginal lending facility rate at 0.30%

Out of the 3 policy rates, the most important one is the deposit facility rate, because at -0.20%, this is the rate that determines how far down the ECB’s QE program can push sovereign bond yields.  More on this below.

One key role of the 19 national central banks

ECB’s QE program runs at a rate of €60 billion a month, but the ECB itself doesn’t conduct the purchases.  Instead, the 19 national central banks are tasked with buying bonds in their respective sovereign bond markets.

Moreover, the amount of purchase is based on each country’s Capital Key, referring to national central banks’ contributions to ECB’s capital, based on each country’s GDP and population.  Naturally, Germany and France dwarf other member countries, hence, the Deutsche Bundesbank and Banque de France are responsible for 26% and 20% of the €60 billion monthly purchase, respectively.

Finally, the -0.20% deposit rate comes into play as a constrain on each national central banks’ QE purchases.  For example, if the Bundesbank is buying German 2 year sovereign bond, and if the 2 year yield drops to -0.20%, the Bundesbank must find something else with a yield above -0.20% to buy, such as the German 5 year sovereign bond.

European Central Bank - capital key
European Central Bank capital key

Politics within the European Central Bank

Mixing 25 people together in any fashion will lead to political drama.  Mixing 25 people representing an economic bloc with uneven growth and major differences on the risk of inflation will lead to unbelievable drama.  I would like to highlight that the French and German member of the Executive Board didn’t get there by chance.

20 of the 25 members of the Governing Council (it is hard to get everyone together)

ECB Governing Council
ECB Governing Council

Members of the Executive Board:

  • President Draghi is 4th from the left at the front row 
  • Vice President Constâncio is 5th from the left at the front row
  • ECB’s Chief Economist Praet is far right at the back row 
  • Benoît Cœuré is 2nd from the left at the front row.  He is “France’s seat at the table,” and he in charge of managing open market operations (including QE)
  • Sabine Lautenschläger is 3rd from the left at the front row.  She is “Germany’s seat at the table.”  Together with Deutsche Bundesbank President Jens Weidmann (4th from the left at the center row), they represent the main opposition bloc to ECB’s QE program
  • Yves Mersch is far right at the front row.  He is mostly charge of financial stability and macro-prudential regulations

Next article10 10 2015 | by Victor Xing | Central Banks

Does the Federal Reserve “need” to begin policy normalization?