THE EUROPEAN Central Bank avoided massive disruption yesterday as euro-zone banks repaid a record €442 billion in emergency funds borrowed a year ago, but strong demand for shorter-term ECB liquidity pointed to significant strains in the bank system.

The return by more than 1,100 banks of 12-month liquidity, injected at the height of the economic crisis, closed down the biggest and one of the highest-profile support facilities provided by the ECB since the collapse of Lehman Brothers in late 2008.

However, news that 78 banks had requested €111.2 billion in a special offer of six-day funds yesterday to carry them over until a regular offer of unlimited seven-day funds next week showed some were still facing difficulties in finding funds.

Ahead of yesterday’s repayment, fears had grown in financial markets that the withdrawal of 12-month loans could create problems for some banks. Spanish and German finance houses had lobbied for the ECB to reconsider. The ECB was anxious to begin weaning banks off emergency help, and feared that lending large sums for as long as a year was distorting financial markets.

The euro’s monetary guardian took comfort this week when demand for the offer of three-month liquidity, at €131.9 billion, fell far short of expectations. That unlimited offer of funds at a 1 per cent interest rate – above market rates – had been arranged by the ECB to smooth the repayment of the €442 billion in one-year loans.

Analysts noted that, even taking into account the funds borrowed yesterday on a six-day basis, the amount of “excess liquidity” in the euro-zone financial system had fallen considerably this week.

“There is some suggestion that banks, I would not say, feel good, but have moved away from panic stations, where they wanted a lot of liquidity at a cost,” said Erik Nielsen, European economist at Goldman Sachs. That apparent progress could convince the ECB it was right to withdraw 12-month loans, which has shifted significantly the term structure of the liquidity it has pumped in.

The withdrawal of excess liquidity and continuing nervousness about the health of some European banks has put upward pressure on market interest rates.

Three-month euribor rates, or the cost for banks to lend to each other, rose 2 per cent yesterday to 0.782 per cent, from 0.767 per cent. They have risen sharply this week, having closed at the end of last week at 0.748 per cent.

The high demand for six-day ECB liquidity yesterday was puzzling – given that banks had also been able to roll their 12-month loans over into three-month liquidity. One explanation was that banks saw a chance of the ECB being forced soon to reintroduce six or 12-month loans, and so did not want to take liquidity at this stage for longer than necessary.

That possibility was played down by analysts. Nick Matthews at Royal Bank of Scotland pointed out that the ECB had already announced further offers of unlimited three-month liquidity for later this month, August and September. “De facto you have got a commitment to unlimited ECB funding until the end of the year.”

An alternative explanation was that banks had become more confident that financial market conditions would improve in coming weeks, which would also have justified a decision not to take liquidity at an above market rate for as long as three months.

The ECB gave no details, but the widespread suspicion was that demand for extra liquidity has been concentrated in southern European countries, where banks’ holdings of domestic government bonds have been hardest hit and worries were greatest about the future ability of the state to bail out banks.