It’s hard not to laugh at the ECB’s latest attempt to stimulate lending to small and medium-sized entities (SMEs).

Please consider ECB Changes Collateral Rules as It Seeks to Boost Lending.

The Frankfurt-based ECB will reduce the risk premium, or haircut, applicable to asset-backed securities to 10 percent from 16 percent, according to an e-mailed statement today. It’ll also lower the quality threshold for six ABS classes that are subject to loan-level reporting requirements to two A- ratings from two AAA ratings. At the same time, the central bank will tighten rules for retained covered bonds so the total effect on eligible collateral will be “overall neutral,” it said.

Policy makers will “continue to investigate how to catalyze recent initiatives by European institutions to improve funding conditions” for SMEs, according to today’s statement, which marks a biennial review of the bank’s risk-control framework. The focus will be on “the possible acceptance of SME-linked ABS guaranteed mezzanine tranches as Eurosystem collateral in line with established guarantee policies,” it said.

The central bank also changed the haircuts it applies to sovereign bonds pledged as collateral in refinancing operations. While it reduced the risk premium on most securities rated at least A-, it raised haircuts on bonds rated from BBB+ to BBB-, the lowest three investment grades. That shift will affect banks that use government bonds issued in countries including Italy and Spain. 

For starters, I rather doubt that the ECB has a clue as to what is really AAA. Next I point out the absurd assumption that sovereign bonds will not default when there have already been defaults and writedowns in Greece and Cyprus.

I happen to think Spain and Portugal are next, with Italy not too far behind.

Here’s the key question: What is the point of lending to SMEs when the main problem is not funding but lack of customers? It seems to me that more lending is a sure path to more bank losses.

And the banks are capital impaired (which  of course is precisely why banks are not  lending more in the first place).  The only reason banks do not appear to be capital impaired is they do not have to mark all their assets to market.

Finally, even if it made sense to stimulate lending to SMEs, is a mere reduction in collateral from 16% to 10% enough? If it is, I suggest it will expose the ECB to losses on its collateral.

“Loosen This Tighten That” as a strategy to stimulate SME lending is ridiculous.

Mike “Mish” Shedlock