ECB strive to prevent credit crunch

The European Central Bank is offering cheap three-year loans in to prevent another credit crunch.

The European Central Bank (ECB) has offered cheap three-year loans in an attempt to prevent another credit crunch. It hoped to lend up to €450bn and has exceeded this by almost €30bn as over 500 banks have raced to borrow from the scheme, benefitting from interest rates as low as 1%.

Jonathan Loynes at Capital Economics has stated that “while this might help to address recent signs of renewed tensions in credit markets and support bank lending”, whether this money will be used to reduce sovereign debt is doubtful, as he believes banks will “use the funds to purchase large volumes of peripheral government bonds.”

While the scheme has been regarded as a positive step, some suggest the money will just be used to boost bank balance sheets, especially since the ECB lowered its collateral requirements when it announced the loans, enabling weaker banks to apply for the funds.

Carsten Brzeski at ING, said: “The good news is that banks won’t have to worry about liquidity for three years and that it has already pushed down government yields, as banks are buying them to use as collateral … whether the ECB’s hope that the money will filter through to the real economy will be fulfilled remains to be seen.”

The ECB’s move comes in the wake of turbulent times for the Eurozone. Banks in countries such as Greece and Ireland have lent large amounts of money to their national governments, and others in the Eurozone, by buying sovereign bonds. Yields have been rising during the past few months, reflecting a higher risk that a country may default.

The banks that are left holding large amounts of Eurozone sovereign debt are in turn seen as risky by money markets who force them to pay more to borrow money. This situation encourages banks to lend less themselves, which trickles down to consumers and small businesses, which find it harder to get loans. Banks taking the three-year loans at 1% are being encouraged to invest in sovereign debt at 6% to 7%, which not only provides a lucrative return for the banks, but increases demand for sovereign debt.

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