The European Central Bank (ECB) gave European banks another shot in the arm this week. Its second longer-term refinancing operation (LTRO) saw over 800 banks borrow €529.5bn at 1% against a wide range of collateral. The first time it offered unlimited money for three years at 1%, in December, 520 banks borrowed €489bn. These are gross figures; strip out roll overs of shorter-term loans and the net sums of printed cash injected into the banking system were €192bn last time and €399bn this week.
What the commentators said
The first LTRO “made a big difference to confidence”, said Laurent Fransolet of Barclays Capital. “It made it clear there was a backstop” for Europe’s shaky banking system. The liquidity injection ended fears of a Lehman’s-style collapse by relieving a severe credit drought in the interbank markets.
It also reduced peripheral bond yields – implied interest rates on these countries’ debts – as banks were encouraged to borrow at 1% and buy Italian and Spanish bonds yielding around 6%. This allayed fears of default and helped calm markets.
“Without the ECB’s intervention it seems doubtful” that markets would have been stable enough even “to discuss a new deal on Greece”, said Iain Dey in The Sunday Times. But the LTRO just buys Europe some time; it doesn’t solve the crisis.
ECB president Mario Draghi hopes the cash will flow into the real economy and end the credit squeeze there. But while banks have plugged holes in their balance sheets and refinanced interbank loans, “there is no sign that [they] are stepping up lending to business and households”, as Simon Tilford of the Centre for European Reform think tank points out. Draghi’s wish “is likely to fall on deaf ears”, said FxPro.com.
A major issue is that banks are still obliged to meet new rules on capital ratios. As it is still hard to raise capital in the markets, this implies shrinking balance sheets and lending. Still-stretched balance sheets are expected to be reduced by more than €1.5trn. And the weakening economy won’t make banks any keener to increase lending.
The economy is a key reason the LTRO is just a stop-gap, said John Plender in the FT. The ECB has addressed Europe’s liquidity problem, but it “cannot remove the solvency issue… to be solvent and reduce debt, southern Europe needs growth”.
Yet the European Commission expects “all of minus 0.3%” this year. Structural reforms will boost growth, but only after a few years have passed. Meanwhile, “all we have is German insistence on fiscal austerity at a time of deficient demand”.
So fears of eventual default in southern Europe are highly unlikely to go away. If there are defaults, Europe’s banks, having loaded up on more sovereign debt due to LTRO, will pose an even greater systemic risk than before. So LTRO isn’t just a sticking plaster. It’s also, as Charles Wyplosz of Geneva’s Graduate Institute put it, a trillion euro bet by the ECB.