ECB - Allow the ECB to reinsure economy-wide risks

While most see the ECB’s role as managing the cost of debt across the eurozone.

Either though direct bond-buying or through setting interest rates.

The ECB’s insurance-function is misunderstood.

While everybody knows they are the lender of last resort, this is in effect an insurance function against bankruns.

Government guarantees have been a policy instrument of regions in order to facilitate lending but those guarantees are not re-insured causing sovereign debt risk.

The ECB could opt to underwrite (e.g. eat the losses) economy-wide risks through a reinsurance-mechanism.

This should be done partially, such that there remains risk with the issuer.

The idea is that ECB should only use this in the capacity of enabling competitive markets.

An example is small debt funds are unable to compete with banks because they are not as diversified as banks and therefore their portfolio risk is too large to lend e.g. 10% of their portfolio to a company.

Another example would be to insure against piracy and terrorism at sea.
Inflation spiked because ships were avoiding the Suez canal, this risk could have been reinsured by the ECB in order to guarantee continuity and counter increased prices from longer travel routes.

Those are examples, they don’t have to become policy but the idea is that ECB can decide to collateralize certain economy-wide risks in order to facilitate competitive markets.

One particularly powerful use, which aligns with the startup world objective would be to underwrite capital guarantees in insurance-based pension policies so that pension funds can invest in startups.

In essence, pension contracts have mandatory guarantees that they should hit which limit what investments they can invest in. A particularly limiting one is the capital guarantee, which means the insurance firm must be able to pay back the originally paid-in capital to the pensioner.

The problem is that every year, the insurance firm must demonstrate that they can hit this guarantee which is a problem in recessions when the stock market is down.

This means they divest in down-markets and reinvest in up-markets.

A simple reinsurance mechanism would liberate them from this problem and the ECB collateralized any losses it incurs. This would be a good mechanism to push pension funds to invest in equity markets.