S&P: ECB 3-LTRO Cut Funding Crisis Risk But Won’t Stoke Loans

Author: Market News International | Category: News

–New ECB Loans Deepen Divide Between Healthy Banks, ECB-Dependent Ones

PARIS (MNI) – The European Central Bank’s new three-year
refinancing operations have reduced the risk of a major funding crisis
in the Eurozone, but they will not prevent banks from shrinking their
balance sheets and constricting loan growth, Standard & Poors said in a
study released Tuesday.

The rating agency also warned that the ECB’s massive long-term
lending has only deepened the divide that already existed between
healthy banks and those that are more dependent on ECB funding. The ECB
pumped E490 billion worth of three-year loans into the banking system in
late December and is expected by some analysts to inject a similar or
even larger amount at the second three-year LTRO to be held next

“The increase in ECB loans to banks and in bank deposits at the ECB
reflects a deepening divide of the European banking industry. The gap is
between the liquid, more credit-worthy banking groups that stockpile
liquidity at the ECB and those that are less credit-worthy and
relatively dependent on central bank funding and on government support
programs in general,” S&P noted. “The larger role of the ECB reinforces
the credit tiering in the industry, in our view.”

The reported cited “high dependence” on ECB funding for the banking
industries of Greece, Ireland and Portugal, with “growing net use” by
banks in Italy and Spain, and a “relatively neutral” position for French
and Belgian banks. The banks in Germany, the Netherlands, Finland,
Austria and Luxembourg, on the other hand, are net lenders to the ECB,
the study showed.

“We may view a significant use of the ECB’s liquidity facilities as
a negative in a bank’s [stand-alone credit rating],” one of the
components in the overall rating, S&P said. Just how negative would
depend on “the ECB’s role in the bank’s funding mix, the maturity
structure of the bank’s assets and liabilities, and the use of the
proceeds” from the ECB loans, it added.

The report also noted that the historically high volumes deposited
by banks with the ECB — a total of E730 billion as of February 3, in
the overnight deposit facility and in one-week term deposits used to
sterilize the central bank’s sovereign bond purchases — shows that the
interbank market is still on very tentative footing.

“In our opinion, the huge amount of very low yielding deposits (25
basis points in the deposit facility, roughly 30-40 basis points on the
fixed-term deposits) indicates that the top-tier banks prefer the safety
of the ECB due to the uncertain conditions in the bank funding markets,”
S&P said, though it conceded that required risk weightings on interbank
loans might also be a factor behind the large bank deposits at the ECB.

The rating agency also noted the “numerous” links between sovereign
risk and bank credit risk, and the rapid two-way transmission between
the two debt markets. “The higher cost of wholesale funding seems a
permanent fixture of the brave new world of banking in the Eurozone,” it

S&P’s assessment of the ECB’s three-year lending program is
strikingly less upbeat than the central bank’s own view. ECB President
Mario Draghi and other top ECB officials have repeatedly argued in
recent weeks that new cash is beginning to circulate in the economy and
that the high level of deposits at the ECB was not necessarily evidence
to the contrary.

The S&P report did note — in line with the ECB’s view — that the
large uptake of the ECB’s three-year loans has reduced the risk of a
funding crisis by lowering borrowing costs, opening up term funding
markets in some cases and giving banks “breathing room” to address their
weak funding profiles.

Nonetheless, it observed that in addition to the higher cost of
interbank funding, there are many banks in Greece, Portugal, Ireland,
Italy and Spain that still have “limited and or no access” to market

“We expect Eurozone banks to continue to deleverage in 2012,” S&P

Perhaps of more concern over the medium term is the fact that in
three years banks will have a huge pile of debt, possibly as much as E1
trillion that they will need to pay back to the ECB, S&P noted.

“The main risk of the ECB funding is that it is temporary and
concentrated in maturity,” the agency said. While the two three-year
LTRO tenders establish a relatively long period for the industry to
adjust, the ECB exit, in our opinion, represents a large risk that will
grow over the coming three years as the first quarter 2015 maturity of
the three-year LTRO approaches.”

In the meantime, there is a danger of future margin calls by the
ECB on the three-year loans due to a possible deterioration of sovereign
creditworthiness, which “could also be destabilizing for the industry,”
the S&P warned.

“This is yet another facet of the links between sovereign and bank
risk we see in the Eurozone,” the report observed. “Erosion in the
creditworthiness of Eurozone sovereigns — or other types of
collateral– could lead the ECB to ask for more collateral to support
the same amount of loans under its LTROs and MROs.”

The agency noted, however, that in such an event the ECB could once
again relax its collateral eligibility rules, as it did earlier this

–Paris newsroom, +331-42-71-55-40; bwolfson@marketnews.com

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