Tomorrow’s ECB refi operation in which it will offer banks funding for a one-year term will be closely watched from a number of angles. The first angle will be the net amount of money pumped into the system from the ECB. The second will be the quality of the collateral the ECB is tendered and the third will be the quality of the borrowers.
It is that third issue that is perhaps the most troubling aspect of the ECB program. Analysts fear that the provision of unlimited liquidity for a one-year period will paper over deep troubles among some European banks. If the economy improves over the course of the year and banking losses are stanched, the ECB’s gamble will pay off. If it does not, it extends the life of banks that likely would have been wound down if not for the refi.
Japan was criticized for not dealing with its troubled banks (and borrowers for that matter) until very late in the “lost decade”. It looks as though the ECB may be committing some of the same offenses.
Near-term, the term refi program may paper over weakness in the banking system (and the EUR), but it may end up just postponing the inevitable.
