Banks May Flock to ‘Free Money’ as ECB Awards 3-Year Loans

By Gabi Thesing and Rainer Buergin - Dec 21, 2011 3:07 PM GMT+0700

The European Central Bank is set to flood euro-area banks with cheap cash as they flock to its offer of three-year loans today.

Banks will ask the ECB for 293 billion euros ($384 billion) of the 1,134-day funds, according to the median of 14 forecasts in a Bloomberg News survey of economists. Estimates range from 150 billion euros to as much as 600 billion euros. The money will be lent at the average of the ECB’s benchmark rate -- currently 1 percent -- over the period of the loan. Results are due at 11:15 a.m. in Frankfurt and the loans start tomorrow.

“This is basically free money,” said Jens-Oliver Niklasch, a strategist at Landesbank Baden-Wuerttemberg in Stuttgart. “The conditions are unbeatable. Everybody who can will try to get a piece of this cake.”

Europe’s debt crisis has increased the risk of government and bank defaults, making institutions wary of lending to each other and driving up the cost of credit. The ECB is trying to ensure that banks have access to cheap cash for the medium term so that they can keep lending to companies and households. In addition to the longer-term loans, the ECB has widened the pool of collateral banks can use to secure the funds.

The euro rose for a second day amid speculation the ECB’s loans will spur demand for sovereign bonds. The 17-nation currency gained 0.3 percent to $1.3123 at 9 a.m. in Frankfurt.

‘Significant’ Demand

Yields on Italian and Spanish government bonds have dropped since the ECB announced the loans on Dec. 8 as banks buy the securities to use them as collateral. French President Nicolas Sarkozy has suggested banks could use the loans to buy even more government debt.

The ECB’s intention is that banks utilize the funds to refinance themselves, Vice President Vitor Constancio said in a Dec. 19 interview. He predicted “significant” demand as banks face “very high refinancing needs early next year.”

Some 230 billion euros of bank bonds mature in the first quarter of 2012 alone, ECB President Mario Draghi told the European Parliament this week.

“Banks represent about 80 percent of lending to the euro area,” Draghi said. “The banking channel is crucial to the supply of credit.” He predicted banks will experience “very significant funding constraints” for the “whole” of 2012.

Capital Requirements

Banks from the euro region need to refinance 35 percent more debt next year than they did this year, according to a Bank of England study. Lenders have more than 600 billion euros of debt maturing next year, around three quarters of which is unsecured, the study says.

“The good news is that banks won’t have to worry about liquidity for three years,” said Carsten Brzeski, an economist at ING Group in Brussels. “However, it remains to be seen whether the money will filter through to the real economy as the ECB hopes. Many banks still have to increase their capital ratios to meet the Basel III criteria by mid-2012.”

Regulators are forcing European banks to increase buffers so they can cope with future crises. The European Banking Authority earlier this month ordered the region’s financial firms to raise 114.7 billion euros of additional capital to bolster their core Tier 1 ratios to more than 9 percent of risk- weighted assets by the middle of 2012.

Faced with a potential credit crunch, the regulator told banks to raise the money from investors, retained earnings and lower bonuses. Failing that, companies may sell assets, provided the disposals don’t limit overall lending to the “real” economy, the EBA said in a Dec. 8 statement.

‘Lender of Last Resort’

The ECB is focusing on greasing the banking system to fight the debt crisis as it resists calls to increase its bond purchases to reduce governments’ borrowing costs. It will also award 98-day loans today and offer a second three-year loan in February. Banks have the option of repaying them after a year.

With the loans, the ECB is showing it “is the lender of last resort for banks, not for sovereigns,” said Royal Bank of Scotland Group Plc (RBS) economist Silvio Peruzzo.

“This will stabilize the banking sector and is another building block in the ECB’s policy to prevent a much dreaded credit squeeze,” said Jan Holthusen, head of fixed-income research at DZ Bank in Frankfurt. “But it’s just one building block and by itself not decisive.”

To contact the reporters on this story: Gabi Thesing in London at gthesing@bloomberg.net; Rainer Buergin in Berlin at rbuergin1@bloomberg.net

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