A man works outside the European Central Bank (ECB) in Frankfurt.MARTIN OESER
More than 500 banks rushed to the European Central Bank's first-ever offer of three-year loans, securing a record amount of emergency funding in a graphic demonstration of the strain in Europe's financial system.
European banks collected the equivalent of about $656-billion, or €489-billion, from the ECB, an astonishing amount considering private bankers tend to avoid borrowing from central banks because it is seen as a sign of weakness. The previous record was €442-billion for 12-month emergency loans, offered in 2009 during the global financial crisis.
Policy makers doled out the money at an extremely low rate of 1 per cent and put no limits on the amount a bank could take. The ECB also loosened its collateral requirements, providing lenders an opportunity to get riskier assets off their books. The demand for ECB funding was greater than many investors were expecting.
Stocks initially jumped on news of the fresh cash supply for banks, but then retreated.
Flushing the financial system with billions more in borrowed money will do nothing to solve the fundamental issues in Europe. Governments are straining to set credible budget policies, while leaders seek a financial backstop that's big enough to assure bond traders that big countries such as Italy won't default. Meanwhile, economic growth has fizzled out.
Still, the ECB's loans are creating time and space for politicians to make those adjustments. Banks are struggling to raise funds because of their large exposure to European sovereign debt. The central bank's offer of cheap money will relieve that pressure, which should keep credit markets from seizing. At a minimum, banks have stuffed their coffers with enough cash to keep themselves from going bust. The stronger among them will be in a position to boost economic growth through lending.
"We are very happy to have been wrong about expecting much less demand," Carl Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y., said in a note to his clients.
The overwhelming demand for emergency funding also casts the ECB and its new president, Mario Draghi, in a more favourable light.
Under considerable pressure to ease the European debt crisis by buying the bonds of troubled members of the euro zone, Mr. Draghi has held firm, stating repeatedly that he is barred from doing so under the terms of the treaty that established the ECB in 1998.
This has caused some to accuse Mr. Draghi of being dangerously orthodox in his approach to debt crisis. But the clamour for a show of overwhelming force by the ECB has missed some of the central bank's more subtle moves. Chief among them was the decision at a policy meeting earlier this month to extend loans for 1,134 days, an extraordinarily long commitment that was made to assure investors that banks would have access to enough cash to ride out the crisis. The ECB is scheduled to make a second three-year offer in February.
"Today markets realize the extent of help European banks are getting," Jimmy Jean, an economist at Desjardins Capital Markets in Montreal, said in a research note. "The move may help prevent or delay one of the major potential catalysts for a euro-area unravelling, which is bank failures."
The 523 banks that took out three-year loans with the ECB on Wednesday borrowed enough to cover about 63 per cent of the total European bank debt maturing in 2012, according to analysts at Goldman Sachs Group Inc.
That's important, given upcoming funding needs. On Monday, Mr. Draghi warned in testimony to the European Parliament that the expiration of €230-billion of bank bonds and €300-billion of sovereign debt in the first quarter of 2012 would put "very, very significant, if not unprecedented" pressure on the debt markets.
Investors were unsure of what to make of the European banks' voracious demand for ECB money. The euro initially jumped, but then stumbled, apparently on the interpretation that the central bank's massive lending shows that Europe's problems are deeper than many thought. The Dow Jones industrial average and the Standard & Poor's 500 index struggled for most of the trading day, then rallied Wednesday afternoon to close higher.
The best case for European policy makers would see banks reinvest the ECB's cheap money in sovereign debt. It could be a profitable trade. The yield on Italian two-year notes, for example, is about 5 per cent, a four-percentage-point gap on what European banks are paying the ECB.
But some investors appear unsure about what the banks will do with the money. The price of Italian two-year bonds fell after the ECB's loan announcement, suggesting weaker demand, not greater.