Can European banks bounce back?
The European Central Bank’s (ECB) unprecedented funding operations in December 2011 and February 2012, which in aggregate provided a little more than €1trn (£818bn) of three-year money to the sector, has materially reduced the risk of a bank failure, and averted the possibility of a severe credit crunch and additional recessionary pressure across the eurozone.
The ECB’s actions have helped warm up public funding markets from the deep freeze of late 2011, although demand from investors remains selective.
Nevertheless, the ECB’s actions do not address the underlying structural issues in the banking sector. Such issues include capital shortfalls at various banks, the questionable viability of some business models in the medium term, and continued uncertainty over the appropriate values of assets such as certain exposures to sovereign debt.
By reducing immediate concerns over the risks incurred in refinancing eurozone debt, the ECB’s intervention has allowed banks more time to adapt their balance sheets and strategies to new developments in regulation and markets. However, the year is likely to remain challenging as banks continue to recognise problem assets, accumulate capital, deleverage and sell or close businesses that are less central to their activities.
The ECB’s actions have helped warm up public funding markets, but do not address the underlying structural issues in the European banking sector
The ECB rides to the rescue
For some time, Standard & Poor’s ratings on banks in the eurozone have been underpinned by an expectation that the ECB would, if necessary, act as a lender of last resort and provide significant, collateralised funding to banks that required it. Even so, the magnitude of the ECB’s support is striking. The December 2011 long-term refinancing operation (LTRO) provided €489bn (£399bn) of three-year money to 523 banks, and a further €530bn was extended to 800 banks at the end of February.
Relative to each sector’s liabilities, there appears to be a higher degree of dependence on the LTRO – and similar facilities offered by certain national central banks – in Greece, Ireland and, to a lesser extent, Portugal. Net usage of ECB funding is growing in Italy and Spain, with a relatively neutral position in France and Belgium. Finland, Austria, the Netherlands, Luxembourg and Germany all have banking industries that are in a net lender position with the ECB.
Many banks tapped the LTRO on an opportunistic basis because it offered relatively cheap term funds. In addition, since regulators and central banks actively encouraged banks to use the LTRO, there was little stigma associated with it. However, a minority depend more on the ECB to ensure they are able to refinance maturing debt.
The LTRO’s low interest rates and flexibility over collateral illustrate the ECB’s willingness to stand in for illiquid interbank and funding markets. For now, the ECB has also averted the risk of a widespread credit crunch and deeper recession, which might have arisen if banks’ concerns over refinancing their significant debt maturities this year had led them to ration new lending severely.