Banks swoop on $832b funding pool

The ECB lending programme is designed to reduce the likelihood that a large private bank will run out of cash next year and be forced into a catastrophic default. Image / Supplied

Banks gorged on €489 billion ($832 billion) of liquidity support from the European Central Bank yesterday as the eurozone's lender of last resort sought to avert a new continent-wide credit crunch.

More than 500 private lenders rushed to swap eurozone sovereign bonds and other assets at the ECB for three-year loans offered at low interest rates.

European banks have been experiencing an intensifying funding squeeze in recent months as fears have grown over their exposure to potentially toxic eurozone periphery sovereign debt. The continent's banks have around €720 billion worth of their own bonds that they need to roll over next year.

The €489 billion borrowed from the Frankfurt-based central bank was considerably in excess of the €250 billion to €350 billion that had been expected.

The ECB lending programme is designed to reduce the likelihood that a large private bank will run out of cash next year and be forced into a catastrophic default.

Yesterday's offer was the largest sum allocated in an ECB liquidity operation since €442 billion in one-year loans were snapped up by banks in June 2009.

"This is good. It's a positive number, at the top end of expectations. You have to regard it as a positive result," James Nixon at Societe Generale said.

Some European politicians, including French President Nicolas Sarkozy, have voiced hopes that private banks will use the cheap funds to buy up the sovereign bonds of struggling nations such as Italy and Spain and help to stabilise the eurozone debt crisis.

Deutsche Bank estimates banks used about half of the €442 billion they borrowed from the ECB in 2009 to buy up Greek and Spanish sovereign bonds.

But analysts were divided over whether this was likely to happen.

"Small banks may be tempted to invest the proceeds of the auction into sovereign bonds, profiting from the huge interest rate differentials," Christian Schulz, of Berenberg Bank, said.

Annalisa Piazza, of Newedge Strategy, said larger banks are also likely to attempt to benefit from the "carry trade" of buying high-yielding peripheral debt with cheap ECB loans.

"Given the large number of banks participating at today's auctions, we cannot rule out some core countries' banks have started to put on some carry positions," she said.

Yet other analysts were sceptical about whether banks would see this as an attractive strategy. "We doubt whether the money will be used extensively to fund purchases of peripheral debt, given concerns about mark-to-market risks and possible reputational risks," Martin Van Vliet of ING said.

Giovanni Sabatini, of the Italian Banking Association, said that the recent actions of the European Banking Authority, which has required banks that hold large sums of peripheral eurozone debt to raise more capital, would act as a disincentive against banks loading up on new European government bonds.

- INDEPENDENT