ECB opens flood gates to turn tide of debt crisis

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The European Central Bank opened the flood gates on Wednesday to drown the debt crisis, injecting a record amount into eurozone banks but analysts were sceptical that it would be enough.

In its first-ever 36-month refinancing operation, the ECB fully met a total 489.19 billion ($641 billion) in bids from 523 banks at a rate of just 1.0 percent.

That is higher than the previous record of 442 billion euros for a one-year auction in June 2009 and came in at the top end of analysts' expectations for 100-500 billion euros.

Stock markets, where sentiment has been higher all week, firmed on the news and the euro held up against the dollar but eurozone bond market rates firmed, except for France.

German banks welcomed the move, which also eases some of the pressures which have caused banks to curb lending to businesses and households.

"It has decisively improved the liquidity situation of the European banking sector," said the head of the German BdB banking federation, Michael Kemmer.

Along with the other liquidity measures announced by the ECB last week, "these are the right and important steps to counter the danger of a credit crunch in the euro area," Kemmer said.

Last week, ECB chief Mario Draghi said the central bank would launch its longest-ever refinancing operation, effectively providing unlimited funds to banks on exceptionally easy terms.

Draghi announced the measure along with a relaxation of rules for the collateral required from banks as guarantees for loans and a reduction in the ratio of reserves that banks must hold at ECB, also freeing up capital.

In addition, EU officials have said there will be no more talk of private bondholders having to bear part of the cost of any future bailouts, another big signal to bolster confidence in bonds.

The ECB has consistently refused to act as the lender of last resort to governments, insisting it was up to countries to get their finances in order.

But it has always made clear it is ready to stand as lender of the last resort for banks.

Nevertheless, "these are just emergency measures which cannot replace a functioning interbank market," said BdB chief Kemmer.

Every effort must be made to restore confidence in the interbank market, he insisted.

Analysts agreed.

"The very heavy take-up provides some encouragement that banks' liquidity needs are being amply met," said Jonathan Loynes, chief European economist at Capital Economics.

While the allocation was much bigger than anticipated and might help to address recent signs of renewed tensions in credit markets and support bank lending, "we remain sceptical of the idea that the operation will ease the sovereign debt crisis too," Loynes said.

There has been much speculation that governments have been pressing banks to use the ECB cash to buy up large volumes of sovereign debt of the troubled eurozone countries.

Many eurozone governments are having great difficulty in borrowing money on the bond market but need to sell huge amounts of bonds next year to fund their mountains of accumulated debt.

At Dutch banking and insurance group ING, economist Martin Van Vliet said: "The (ECB) allocation for three years today is the equivalent of nearly one and a half times the bond issuance programmes of Spain and Italy in 2012."

Banks have generally been cutting their exposure to sovereign debt in recent months and would be reluctant to invest the ECB cash in what they continued to view as risky assets, said Loynes at Capital Markets.

Even if they did, "the amounts involved are not a substitute for the much bigger purchases, or guarantees, which markets have been hoping for from the ECB itself," Loynes said.

Christian Schulz, senior economist at Berenberg Bank also saw the huge allotment as "a significant step to relieve European banks of funding pressures.

"With such generous support, the spectre of financial institution bankruptcies because of liquidity issues should recede, removing one of the risks that could lead to a deterioration of the sovereign debt crisis," he said.

However, whether the auction would also help to restore confidence in sovereign borrowers in the euro zone "remains to be seen," Schulz said.

Small banks could be tempted to invest the proceeds of the auction into sovereign bonds in order to profit from the huge interest rate differentials.

But large banks might be much more reluctant and resist pressure to do so.

In addition, banks are negotiating with Greece on losses of about 50 percent on their holdings of Greek bonds.

They would therefore wait to see whether governments made credible progress with austerity and succeeded in implementing the new tougher fiscal regimes, Schulz said.

© 2011 AFP

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