European Banks have sucked up €529.5 billion in cheap money from the ECB. It’s the second auction by the European Central Bank in its Long Term Refinancing Operation.
The money will help improve liquidity in the market. Stock markets have reacted positively. Analysts also expect that over €100 billion of the new LTRO are likely to be used to refinance current debt, while a significant sum will be deposited at the ECB.
The ECB auctions raises some concerns though. Regular liquidity injections can make the European banks addicted to “free money” from Frankfurt and lower risk management within the financial institutions.
In December last year, the ECB provided 523 banks with the loans of €489 billion for more than 3 years at a rate of 1%. As a result, the situation on the interbank lending market improved and the Euribor rate dropped to under 1%.
The other effect was the increase of investments in sovereign debt securities, which caused a slight decrease in levels of bond yields of the eurozone countries. In January, Spanish banks increased their investments in government debt to €23bln, and Italian banks by €21bln. As a result, some unreliable banks have become significant debt holders of the indebted countries. Any distress with the latter could cause a domino effect of the debt crisis with the ECB eventually taking all the credit risks.
On Tuesday (February 28) the ECB said it would not take the Greek bonds as collateral for new loans. The decision was made after the S&P downgraded the rating of Greece to SD (selective default). The International Swaps and Derivatives Association is expected to decide if Greek debt restructuring is a “credit event”. If the answer is yes, this will trigger $70bln CDS payments- contracts that protect bondholders against default by a borrower- acting as insurance for Greek debt. Private investors: banks and insurance companies hold €200 billion of Greek bonds.