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The European Central Bank Loans: Crisis Averted?

In just the first three months of 2012, euro zone banks and governments have around $500 billion in bonds coming due. And because much of that will need to be refinanced, banks and governments will have to compete for investor funds. That means the bond market could face “unprecedented” pressure… and it means that if the competition is too stiff, and if it is too expensive for banks to raise money, they could make fewer loans to consumers and small businesses. Last Monday European Central Bank President Mario Draghi warned parliament that they “don’t want a recession due to funding pressure”, and 2012 “is going to be a difficult year for banks”. European governments (even Germany) have had a hard time issuing bonds.

That risk is why the ECB acted last Wednesday, lending a record $645 billion in three-year loans to euro zone banks…eclipsing the amount lent during the financial crisis, and the largest amount ever lent in a single operation. And the money is cheap, at 1%. The loans will increase the ECB’s balance sheet by 20%… and estimates suggest that the loans will flood the system with €193 billion.

A total of 523 banks (the ECB is not releasing the names) took the loans. More like they devoured the loans. Enough was borrowed to refinance 2/3 of the debt that will mature in 2012.

But it’s not the amount of money borrowed…it’s what the banks will do with it that really matters. The obvious thought is that these loans are really just an indirect, back-door government bailout…in other words, the ECB provides banks with cheap liquidity and in turn they buy euro zone sovereign debt. Banks could profit…borrow at 1% and lend it to euro zone governments at much higher rates. Whether banks will want to do that is a question mark… particularly given that many are already facing potential losses on their government bond holdings. And on the other hand, they could decide to use the funds to shore up their own balance sheets…and again, with the amount borrowed, they could be well on their way to pre-funding their debt maturities for next year. And given that the region’s banks will need to refinance around €600 billion next year (3/4 of which is unsecured) that is a good possibility. Whatever they do with the funds, this was an offer that banks simply could not refuse.

And in a way, the ECB may have already gotten a little of what it was looking for. The bond market reacted to the loans before they were official, with government debt issued at a friendlier rate. As banks were still putting in their loan requests, Spain issued six-month debt at 2.4%…last month it was issued at 5.2%.

By greasing the skids of the financial system, the ECB at least stemmed the crisis, but this is not really a turning point. This, like other measures, treats the symptoms rather than curing the underlying problem. It is no long-term solution, but at least in the short-term, disaster has been averted.


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