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Friday, January 25, 2013

A vote of confidence? Banks start repaying ECB long term loans

This morning saw the start of the on-going process of repayments of the loans given by the ECB to European banks under the Long Term Refinancing Operation (LTRO) (see here for details).

The ECB announced that 278 banks have already pledged to repay €137.2bn. This compared to the 523 banks in total that borrowed around €190bn in net liquidity from the first LTRO at the end of 2011. The amount repaid was above expectations – below we assess why this may have been and what it could mean for the eurozone.

Why have banks decided to repay so much so early?
- A big motivating factor is reputation. It is clear that banks which repay early can highlight that they have access to market funding at low levels and have a sustainable business model.

- Although the loans seem cheap with the low ECB rate they require lots of collateral (to which haircuts are applied). This cost mounts up and some banks (particularly in northern countries) can now borrow on the markets more cheaply. ECB funding is also secured (against the aforementioned collateral) this ties up lots of banks assets, many may prefer to seek unsecured market funding, even if it is a bit more costly.

- Having huge amounts of excess liquidity just parked at the ECB is not efficient or effective. It also distorts bank balance sheets and may detract from other goals such as deleveraging or recapitalisation (more on this in a minute).
What does this mean, if anything, for the eurozone?
- There are fears over a two-tier banking system between those stronger banks funding themselves on the market and those reliant on the ECB. We would add that this furthers the divergence in the eurozone since the split is broadly along the existing strong/weak country divides.

- If the move is to aid banks in deleveraging this could perversely have a negative effect on the eurozone, with banks decreasing lending and reducing demand for euro (particularly peripheral) assets.

- That said the net impact on liquidity is limited, with excess liquidity in the system still at almost €700bn. It may need a further €200bn to be removed before the impact is substantially felt in terms of borrowing costs and demand for assets in the eurozone.

- There could well be a confidence boost from the higher than expected repayment. However, if this furthers a strengthening in the euro there could be growing concerns that it could begin to hamper exports in the weaker economies (a key driver of growth when both public and private sector are limited spending). This also furthers tensions within the one-size-fits-all monetary policy.
So, there are some clear reasons for repaying the loans early, although what it means for the eurozone and the impact it could have is far from clear (this is partly because the actual impact of the LTRO beyond helping banks fund themselves is far from clear). 

One more thing: many analysts are now making a song and dance about the reduction in the size of the ECB balance sheet - seeing it as a great positive. Which it is of course. But strangely, the same people always made the point that the ECB's expanding balance sheet, really wasn't that importance. So which is it?

In any case, as we said at the start, this is a rolling process and the full impact will not be clear for some time. The most important point to watch now is the location of the banks which announce that they have repaid. If it turns out to be solely northern banks, we could see some divergence emerging in the banking system, at just a time when eurozone 'bank union' plans are trying to unify it.


Anonymous said...

It is common knowledge that Bank’s have lost all credibility.

If repayments were made in a normal way then why would all these banks pay so much in one announcement?

Where on earth are the banks or financial institutions conjuring up almost 150 billion euros, with the EU in recession and any collateral they have now cannot be worth more than it did six months ago?

If these Banks are having loans from the financial institutions, then why is the market lending again, when only months ago they were charging astronomical interest rates?

Would it really be possible that the ECB printed money and is in the process of writing off bad debt?

To avoid negative comments, the public should be told which banks are returning their money, how much is involved, and where the money came from.

Unless there is complete transparency it could be assumed the whole EU financial crisis was engineered to pressurize the Euro Area citizens pay the Bank’s debts, surrender their sovereignty, and be forced into a European state. These wild thoughts generate from a lack of information.

Jesper said...

We'll see the change, if any, to the Target2 balances.

This is about US banks, can't say that it is much different in Europe:

Combine it with this:
Fraud isn't being prosecuted if done by individuals working for large US banks. That might make rational investors reluctant to invest in US bank generated bonds. Might be that the (admired for some reason?) US strategy makes investing in Europe seem like the safer option.

Jesper said...

Does this impact the credibility of the European Banking Authority:

"Con Horan, the man in charge of supervising Anglo Irish Bank and Irish Nationwide for the Financial Regulator during the final years of the property bubble, is set to stay on in Europe for an indefinite further period of time."

It will be interesting to hear him in court: Did he see irregularities but didn't report them or didn't he see any irregularities? Neither answer is likely to be appropriate for someone working as a regulator.

jon livesey said...

If you think of sovereign debt as investors graciously lending to Governments, you are slightly missing the point.

Financial institutions, such as pension funds, insurance companies and endowments, have fixed and predictable liabilities, so they have to have safe and predictable income.

Sovereign debt that can't default qualifies, and sovereign debt that can default does not.

When Draghi said the ECB would do "everything it takes" he turned most peripheral euro debt from unsafe to safe in five seconds. He was announcing that "most" peripheral debt would be monetized instead of defaulted. At that point it qualified as safe debt.

The gulf in yields between Greece/Cyprus and the rest of the periphery is the gulf between default and monetization.

Lisa said...

I think it’s good that banks have started repaying their loans. Debt is the enemy of healthy economy and it’s necessary to pay off debts to get bank to the economic stability. But I think it’s still hard to predict something about European crisis. On one hand, things are getting better but on the other hand it’s still hard to say that everything is okay and soon the crisis will go away. Many people still live through payday lending and don’t trust banking institutions.

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