Banks took a huge €489 billion at the European Central Bank's first ever offering of three-year funding today, providing hope a credit crunch can be avoided and that the money may be used to buy Italian and Spanish debt.
A total of 523 banks borrowed money at the tender with the final demand well above the €310 billion expected by traders polled by Reuters in the run-up to the operation.
The ECB move comes as economists expect the eurozone to enter a mild recession in 2012 — which would make it even harder for debt-laden governments such as Italy to get a handle on their debt burdens.
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 37-month term of the most recent round of loans allows banks to get the money need to pay off large chunks of their own maturing debts in the first part of the new year.
In addition to the longer-term loans, the ECB has widened the pool of collateral banks can use to secure the funds.
It hopes the limit-free, ultra-cheap and ultra-long funding will have a range of beneficial effects, including bolstering trust in banks, easing the threat of a credit crunch and tempting banks to buy Italian and Spanish debt to use them as collateral.
French president Nicolas Sarkozy has suggested banks could use the loans to buy even more government debt.
Rather than a simple flat rate, the three-year funds were offered at an interest rate which will be the average of ECB's main interest rate over the next three years. That benchmark rate is, after a rate cut earlier this month, currently at a record low of 1.0 per cent.
For some banks, the money could be more than 3 percentage points cheaper than they can get on the open market. As part of the deal they could switch money borrowed from the ECB back in October into three-year funding and will also be able to pay it back after just a year if they so wish.
Another factor boosting demand is that banks are now more reliant than ever on central bank funds. The ECB said, in its semi-annual Financial Stability Review on Monday, that this dependency could be difficult to cure.
French banks have almost quadrupled their intake of ECB money since June to €150 billion, while banks in Italy and Spain are each taking more than €100 billion.
ECB president Mario Draghi has been pressing banks to take the money since announcing the plans earlier this month. He warned of a chance of a credit crunch on Monday and said that euro zone bond market pressure could rise to unprecedented levels early next year.
Banks switched €45.7 billion out of one-year loans taken from the ECB. The impact on overall liquidity levels was also softened after banks scaled down their three-month borrowing from the ECB to €30 billion from €140 billion and almost halved their intake of one-week loans this week.
"What the ECB wants is that the funds be used by banks to keep handing out loans," said Michael Schubert, an economist at Commerzbank AG in Frankfurt. "But there's a second argument, which is to do carry trades by borrowing on the cheap at the ECB and buying sovereign bonds. We don't know what the banks are using the money for."
Agencies
