Tuesday, February 28, 2012

European Central Bank cheap money

Last December 2011, the European Central Bank (ECB) decided to lend money to private bank across Europe. This move can be defined as similar to the 2008 US Federal Reserve move in favour of US banks which kept the entire banking and investment system from collapsing.

Mario Draghi, ECB President
The european financial institution lent 489 Bn EUR through a 3-year term low interest (1%) loan : LTRO, Long Term Refinancing Operation of the ECB. This peculiar ECB action prevented a credit crunch because all the analysis and figures showed an increase tightening in credit lending to SME's and individuals in Europe (and huge problem of liquidity for private european banks).

This cheap-money wave couldn't have been refused by banks because there were no limitations on what the banks had to do with the money ! They can keep the amount for their balance-sheets, buy sovereign bonds, invest, lend with a higher interest rate,...As it turns out, the bank's appetite for the risk should be limited (or ruled) by ECB before lending this money. As a matter of fact, this won't happen !

source: Reuters

Wednesday Feb. 29, the ECB will renew its LTRO with a hypothetical 450 to 500 Bn EUR loan (it will depend on the demand). The operation will be launched at 9.30 am and the deadline for the submissions of bids will be 10.05 am. ECB stated that they will to stop lending cheap money after this second LTRO.

Let's be clear, Europe faces the same problem the US financial system faced in 2008. You can't spread cheap money to financial institutions that do not comply with rules. A lot of european banks should reduce their liabilities and assets. 

Some banks such as Lloyds, which did not use the December LTRO, has declared that they will apply for a 10 Bn EUR loan. According to the Financial Times, the money will be used to part-fund a portfolio of close to 30 Bn EUR of eurozone lending, focused on Ireland, the Netherlands and Spain, which is set to be wound down over the next three years.

Cheap money is not the accurate response for a long-term strategy, it only put fuel that feeds the fire ! Our fear is that these moves could lead towards a potential bubble into the european bank sector and, then, maybe lead towards the next financial crisis !

Roberto De Primis

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