ECB lends banks $639 billion over 3 years

by lexie Wed Dec 21, 2011 10:26 am

AP – 6 mins ago.. 12/21/11

ECB lends banks $639 billion over 3 years

FRANKFURT, Germany (AP) — The European Central Bank loaned a massive euro489 billion ($639 billion) to 523 banks for an exceptionally long period of three years to steady a financial system that is under pressure from the eurozone debt crisis.

It was the biggest ECB infusion of credit into the banking system in the 13-year history of the shared euro currency.

Wednesday's loans surpassed the euro442 billion ($578 billion) in one-year loans from June, 2009, when the financial system was reeling from the collapse of U.S. investment bank Lehman Brothers.

The ECB is trying to make sure that banks have enough ready cash so they can keep on lending to businesses. Otherwise, a credit crunch could choke off growth and spread the debt crisis to the wider economy through the banks.

Markets rose modestly on the amount of the loans, which was far higher than the euro300 billion expected. Stocks across Europe were higher while the euro was heading back up towards $1.32.

"The fact that the ECB is taking this step is a good thing," said Louise Cooper, markets analyst at BGC Partners. "It is helping to alleviate some of the strains within the system and does on the margin help banks fund themselves."

Helping the banks may be crucial in the year ahead, as many economists think the eurozone may be headed for recession. Slowing growth would make it even harder for the over-indebted governments that are at the heart of the eurozone's crisis to get a handle on their debt burdens. A default on debt payments by a country such as Italy or Spain could cause a new financial crisis and send the global economy into recession.

The 37-month term of the loans permits the banks to stock up on money for a much longer period and reduces stress on their finances. Many banks have had trouble borrowing from other banks or by issuing bonds as they do in normal times. That is because lenders fear the banks may suffer losses from the crisis and not pay them back.

Additionally, banks need to pay off large amounts of their own maturing debts in the first part of the new year. The concern has been that if they cannot borrow to refinance those obligations they will find the money by cutting back on making loans to businesses. Those loans enable businesses to operate day to day, expand their operations and hire people.

The ECB has served as lender of last resort for banks when they cannot borrow elsewhere. ECB president Mario Draghi has stressed the central bank's role in supporting banks even as the bank has refused to play that role for the indebted governments themselves by buying large amounts of their bonds.

Draghi says governments must be the ones to reduce their spending and deficits, and should not depend on a central bank bailout.

In contrast to its tough line with governments, the bank has made easy and abundant credit to banks its main tool in dealing with the effects of the eurozone's two-year-old financial crisis.

Italy and Spain have been at the center of investor concerns in recent months as their borrowing costs have risen. Those two are considered big to bail out with the current eurozone bailout funds, in contrast to Greece, Ireland and Portugal, which have all sought outside financial help. Italy, for example, has some euro1.9 trillion in outstanding debt.

Alongside its efforts to shore up the banks, the European Central Bank has also been cutting interest rates to support the ailing eurozone economy. It has reduced its main refinancing rate from 1.5 percent to 1.0 percent over the last two monthly meetings in the hope that lower borrowing costs will stimulate growth by making credit cheaper for businesses.

Under the terms of Wednesday's loans, the banks will pay the average refinancing rate over the three years. The ECB reviews the rate each month and it will almost certainly change. Banks also have the flexibility of repaying the money after a year if their situation improves.

Still, the credit infusion only treats one of the worst symptoms of the debt crisis. It does not remove the reason people will not lend to banks — their thin levels of capital reserves against potential losses.

"I just want to point out that the ECB is not curing the banking illness, it is merely given banks an aspirin to take away the pain," said BGC's Cooper.

European officials are pushing banks to raise more capital — but it's not an easy task in the current environment. Investors are leery of putting more into banks, and it would be politically unpopular for governments to do it.

The ECB loans also do not do much to reduce heavy levels of government debt. There was some speculation that banks could borrow money cheap from the ECB operation and buy higher-yielding government bonds.

But many analysts think it is unlikely they will increase their exposure to government bonds amid fears of default. Many banks have cut their holdings of debt from governments that are in financial trouble.

http://news.yahoo.com/ecb-lends-banks-639-billion-over-3-years-103603540.html