Trichet Keeps Banks Afloat as Governments Confront Risk of Greek Default

By Gabi Thesing and Jeff Black - Oct 7, 2011 3:41 PM GMT+0700
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The European Central Bank (ECB) sculpture is reflected in a window in Frankfurt, Germany. Photographer: Hannelore Foerster/Bloomberg

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Oct. 7 (Bloomberg) -- Cormac Leech, an analyst at Canaccord Genuity Ltd., discusses the state of Europe's banking industry after Moody's Investors Service cut the debt ratings of banks in the U.K. and Portugal. He talks with Owen Thomas on Bloomberg Television's "Countdown." (Source: Bloomberg)

The European Central Bank’s move to keep euro-area banks afloat is buying governments more time to recapitalize them as Greece edges closer to default.

The ECB said yesterday it will reintroduce yearlong loans, giving banks access to unlimited cash through January 2013, and resume purchases of covered bonds to encourage lending. At the same time, the European Commission is pushing for a coordinated capital injection into banks and German Chancellor Angela Merkel said policy makers “shouldn’t hesitate” if it turns out financial institutions are undercapitalized.

“Politicians, including Angela Merkel, have finally realized the urgency in protecting banks as a Greek default can no longer be ruled out and no-one wants a Lehman in Europe,” said Christoph Kind, head of asset allocation at Frankfurt Trust, which manages $24 billion. “From its side, the ECB is making sure that banks won’t face funding issues throughout that period.”

Financial shares advanced yesterday after Merkel fed speculation that policy makers are working on plans to boost bank capital to stem the spread of the sovereign debt crisis. Europe’s rescue fund, the European Financial Stability Facility, could be relied upon as a last resort to bolster banks if needed, she said, adding that Germany is ready to discuss possible bank aid at this month’s European Union summit.

Euro, Stocks

The euro headed for a weekly advance after two weeks of losses, trading at $1.3448 at 10:36 a.m. in Frankfurt. Stocks gained for a third day in Europe after the overnight advance in Asia, with the Stoxx 600 up 0.7 percent to 231.8 at 9:00 a.m. in London.

European leaders are under pressure from global counterparts to find a solution to the debt crisis as it threatens to tip the world economy back into recession. EU leaders hold a summit on Oct. 18 followed by a meeting of the Group of 20 on Nov. 3-4. French President Nicolas Sarkozy said today he will discuss banks with Merkel when he visits Berlin on Oct. 9.

Germany’s Deutsche Bank AG on Oct. 4 scrapped its profit forecast and announced 500 job cuts and further writedowns on Greek bond holdings, while Belgium’s Dexia SA is facing its second bailout in three years.

The ECB’s measures buy banks “a lot of time as Europe is basically moving toward recapitalizing the sector,” said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Plc in London. “Where the ECB can and does contribute very aggressively is to breaking the nexus between the sovereigns and the banks.”

ECB Purchases

The ECB will spend 40 billion euros ($53 billion) on covered bonds from next month and offer banks two additional unlimited loans of 12 and 13-month durations, President Trichet said at a press conference in Berlin yesterday after leaving the benchmark interest rate at 1.5 percent. The ECB will continue to lend banks as much money as they need in its regular refinancing operations at least until July 2012.

The ECB used the same measures during the global financial crisis to avert a credit crunch.

The 2.5 trillion-euro market for covered bonds -- assets backed by mortgages or public-sector loans -- underpins much of Europe’s real estate lending, which almost ground to a halt in the wake of Lehman Brothers Holdings Inc.’s collapse in September 2008.

Fear Factor

Banks’ overnight deposits with the ECB jumped to the most in more than a year this week as concern about other institutions’ sovereign debt holdings discouraged them from lending to each other.

“For the banking sector the focus is more on liquidity rather than capital,” UniCredit SpA Chief Executive Officer Federico Ghizzoni said in an interview published yesterday.

Policy makers are “determined to do everything necessary to ensure that Europe’s banks are able to play their essential role in lending,” commission President Jose Barroso told reporters in Brussels yesterday. “Close coordination at European level is essential.”

Chairing his final rate-setting meeting before handing the reins to Italy’s Mario Draghi at the end of the month, Trichet resisted calls to reverse two rate increases earlier this year even as the debt crisis threatens to tip Europe back into recession.

Klaus Baader, co-chief economist at Societe Generale SA in London, said the ECB’s decision to focus on greasing the banking sector rather than cutting rates “is a completely appropriate reaction to the current conditions” as “the problem in the euro area is not an excessively high level of short term interest rates.”

Risk to Growth

Still, the crisis has “started to infect the real economy,” said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt.

The ECB in September cut its growth forecasts to 1.6 percent from 1.9 percent for 2011 and to 1.3 percent from 1.7 percent for 2012. Euro-area service and manufacturing industries last month contracted for the first time in more than two years.

Deutsche Bank Chief Executive Officer Josef Ackermann blamed the slowdown in Europe for his bank’s troubles. About 42 percent of revenue from the bank’s sales and trading operations came from Europe last year, Ackermann said on Oct 4.

The bank will write down its Greek sovereign debt holdings by about 250 million euros for the third quarter after a 155- million-euro value reduction at the end of the second quarter.

Banks Gain

France’s Natixis (KN) and BNP Paribas (BNP) SA were among the biggest gainers on the 46-member Bloomberg Europe Banks and Financial Services Index yesterday. Natixis climbed as much as 13 percent, while Paribas was up as much as 7.8 percent.

Trichet yesterday said European banks and supervisors including the European Banking Authority should do everything they can to address the need for recapitalization and banks shouldn’t be reluctant to accept state help when needed.

“There finally seems to be a plan in Europe and what the ECB did yesterday certainly complemented that,” said Gilles Moec, co-chief European economist at Deutsche Bank in London. “The ECB has always been ready to step up to the plate if governments show a willingness to shoulder responsibility. It wasn’t always the case in the past, but it looks like it’s coming together now.”

To contact the reporters on this story: Gabi Thesing in London at gthesing@bloomberg.net; Jeff Black in Frankfurt at Jblack25@bloomberg.net.

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net