ECB said 523 banks had taken advantage of the scheme
By Shavasb Bohdjalian
Market participants were not impressed with the latest funding support provided by the European Central Bank (ECB) through 3-year LTRO loans, with the euro coming swiftly under selling pressure.
The ECB said 523 banks had taken advantage of the scheme that allowed them to offer lower-grade collateral in exchange for loans in excess of EUR 500 bln pegged to the central bank's main interest rate, currently at a record low of 1%. Market sources suggest that Italian banks had accounted for EUR 116 bln of the total with the higher than anticipated take-up seen as proof of funding problems at European banks.
While the ECB has been resisting calls for it to officially print money similar to the Fed and the Bank of England to buy bonds and force long term rates lower, the market sees the long term repo operation (LTRO) as the ECB’s equivalent of Quantitative Easing, which means that everything being equal, the ECB action of providing EUR 500 bln in 3-year loans on very bad collateral is QE in disguise and should add selling pressure on the euro.
The ECB is hoping that the banks, having borrowed for 3-years at 1% will turn around and invest the money (or most of it) in the bonds of the troubled peripheral countries like Italy and Spain, now offering a yield of 6% and not only book a big profit on their books, but also help drive yields lower. Lenders call it the "Sarko trade" after French leader Nicolas Sarkozy said the liquidity will allow each state to "turn to its banks" for finance.
Mario Draghi, the ECB's president, has insisted that no stigma was attached to banks applying for the loans, which for some is more than three percentage points cheaper than they could obtain on the open market.
"We are trying to avoid a credit crunch," Draghi told Euro MPs, warning that EMU banks and states must together raise EUR720 bln over the first quarter of 2012.
The borrowing of EUR500 bln by the 523 banks represents nearly two thirds of all the European bank bonds maturing in 2012. It is almost 1-1/2 times the 2012 combined sovereign bond issuance of Spain and Italy.
The ECB will follow up with another similar operation in February in a move designed to directly help banks which need to raise capital.
This subtle form of 'credit-easing' includes a cut in the reserve requirement to free up EUR100 bln in lending power, and looser rules to allow collateral-starved banks to pawn more of their loan books at the Frankfurt lending window.
Yet it is unclear whether the gamble will pay off and by offering unlimited liquidity to banks, the ECB alone can stop investor flight from the bonds of Italy and Spain as well as core Europe which most nations facing a rating downgrade. European banks have already cut holdings of EMU bonds by EUR65 bln this year, and are slashing loan books to meet the EU's core Tier 1 capital ratio of 9%. The Basel-based Global Stability Board fears that deleveraging could reach EUR2.5 trillion over coming months, risking a shock to the system.
Hardly encouraging were comments from European Commission President Barroso, who said that the EU is still not fully equipped to defend the euro and that the question is whether political
will exists to keep the euro. Against this backdrop, BNP Paribas recommended selling into any EUR year-end rally; with the 1.32-1.3250 area seen as proving tough resistance.
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(Shavasb Bohdjalian is an approved Investment Advisor and CEO of Eurivex Ltd., a Cyprus Investment Firm, authorized and regulated by CySEC, license #114/10 and approved by the Cyprus Stock Exchange to act as Nominated Advisor for listings on the Emerging Market. The views expressed above are personal and do not bind the company and are subject to change without notice)
