Will EU banks deepen their dependence on ECB?

Facing a frozen interbank loan market and minimal investor interest in unsecured bank debt, a Bloomberg article looks at whether EU banks will deepen their dependence on the ECB.

Hopefully the banks will.

It is much easier to clean up the losses hidden on and off the banks' balance sheets as recommended under the blueprint for saving the financial system if the banks' funding is stable.  No funding is more stable than the combination of guaranteed deposits, ECB loans and equity.

European banks, shunned by investors and each other, may borrow as much next month from the European Central Bank as they did in a record offering in December as they seek refuge from frozen funding markets. 

The ECB last month lent banks an unprecedented 489 billion euros ($637 billion) for three years. 

Analysts said they expect demand to be just as high at a second auction on Feb. 29 because the stigma associated with using the facility is dissipating and the list of what assets can be used as collateral in exchange for the loans will be extended. 

ECB President Mario Draghi said last week he expects demand for loans next month to be “still very high,” though “probably lower than in December.” 

“February’s second three-year Long Term Refinancing Operation looks set to be extremely large,” Credit Suisse Group AG analysts led by William Porter wrote in a report to clients. “The last LTRO has removed any stigma, making managements who do not exploit the value on offer arguably careless at best.”...

“People aren’t prepared to lend to the banks, so the ECB is just flooding the market with liquidity,” said Christopher Wheeler, an analyst at Mediobanca SpA in London. “But it’s only a temporary fix. The ECB is only buying time with these loans hoping that things will improve.”...

Regular readers know that your humble blogger predicted the freezing of the capital markets to the EU banks as that absence of ultra transparency makes it impossible to determine which banks are solvent and which are not.

In addition, regular readers know that central banks providing liquidity only buys time to address the underlying solvency issue.

Demand from more than 500 lenders in December dwarfed the 293 billion-euro estimate of economists surveyed by Bloomberg News. 

Half of the loans were taken up by Italian and Spanish lenders, Morgan Stanley analyst Huw van Steenis said in a Jan. 18 report to clients. 

Italian banks were the main users, with UniCredit SpA (UCG), the country’s largest lender, taking 12.5 billion euros, Intesa Sanpaolo SpA (ISP), the second-biggest, accepting 12 billion euros, and Banca Monte dei Paschi Di Siena SpA (BMPS) 10 billion euros, the Morgan Stanley analyst estimated, citing conversations with 50 banks and policy makers. Spokesmen for the three banks declined to comment. 

Spain’s Banco Popular Espanol SA (RBS) took 6 billion euros, while Banco Bilbao Vizcaya Argentaria SA (BBVA) used 5 billion euros, according to Morgan Stanley. Bankinter SA (BKT) used 5 billion euros Chief Executive Officer Maria Dolores Dancausa said in a news conference in Madrid on Jan. 18. A spokesman for Popular wasn’t immediately available to comment. BBVA declined to comment.

French banks BNP Paribas (BNP) SA, Societe Generale (GLE) SA, Credit Agricole SA and BPCE SA all borrowed from the ECB though declined to say how much, Morgan Stanley said. Spokespeople for the banks declined to comment. Royal Bank of Scotland Group Plc, the U.K.’s largest government-owned lender, took 5 billion pounds ($7.8 billion), according to the analysts. An RBS spokesman declined to comment. 

In all, banks may borrow between 150 billion euros and more than 400 billion euros next month, van Steenis said. “It seems even large cap banks have been open-minded to using this given the size and lack of stigma of the first one,” he wrote....

Given that there is no longer any stigma attached to borrowing from a central bank, central banks and the borrowing banks should fully disclose the loans at the time they are made.

Other analysts said the ECB’s decision to ease the rules on what banks can post in collateral in exchange for the loans could push demand higher. Draghi announced the ECB would relax the collateral requirements at a press briefing on Dec. 8. Details on the new rules have not yet been published. 

“The ECB is still deciding what will constitute acceptable collateral,” Marchel Alexandrovich, an economist at Jefferies International Ltd. in London said. “If criteria are loosened enough, then demand for cheap money will undoubtedly swell up and we may well see a figure in excess of 1 trillion euros” at next month’s operation. 

Credit Suisse’s Porter said he expects banks to borrow slightly more than in December, about 500 billion euros, because lenders won’t want to be put at a competitive disadvantage when their peers can borrow cheaply from the ECB. 

“This will remove some of the refinancing risk the banks face and the markets are reacting positively after a bit of a delay,” Porter said in a telephone interview. “But the more fundamental question is how ‘long can you run a banking system like this?’”

Based on the experience of banks in Japan, the answer is over 2+ decades.

Ultimately, the real question is how does the ECB or any other central bank exit from this program of providing the banks with the funding that the private market refuses to provide.

Regular readers know that the answer to this question is by providing ultra transparency.  It is only when market participants can independently evaluate the solvency of each bank that they will be willing to provide the banks with funding on attractive terms.