The ECB Lends $621 Billion To The Banking System

An effort to unclog lending

By Gabi Thesing

June 24 (Bloomberg) — The European Central Bank said it will lend banks 442 billion euros ($621 billion) for 12 months, the most it has ever allotted in an auction, as it steps up efforts to unblock credit markets in the 16-nation euro region.

The Frankfurt-based ECB filled all bids in its first offer of 12-month loans to banks at the current benchmark interest rate of 1 percent. The 1,121 banks that participated receive the funds tomorrow. The euro interbank offered rate, or Euribor, for 12-month loans fell to 1.57 percent today, a record low.

“It’s even more than our most optimistic scenario would have suggested,” said Christoph Rieger, a fixed income strategist at Commerzbank AG in Frankfurt. “There is so much liquidity around that it will push money-market rates to new record lows.”

The ECB, battling Europe’s worst recession since World War II, is concentrating its efforts on lubricating the banking system, which accounts for about three quarters of company financing in the region. The central bank has cut interest rates to the lowest on record and will next month start buying 60 billion euros of covered bonds to help free up credit.

Today’s allotment is “broadly equivalent to one third of all sovereign issuance in the euro zone this year,” said Erik Nielsen, chief European economist at Goldman Sachs Group Inc. in London. “It’s a big number, providing the intended monetary easing by stealth. I suspect that the ECB is very pleased.”

‘Awash With Liquidity’

The ECB has been lending banks as much money as they want against eligible collateral for up to six months since October last year. It announced in May it would extend the maximum maturity on its loans to 12 months. Today’s is the first of three auctions planned for this year, with the others to be held on Sept. 29 and Dec. 15.

“For the other two the ECB could potentially decide to add a small spread” to the fixed rate, said Elga Bartsch, chief European economist at Morgan Stanley in London. “The market finds itself awash with liquidity and the Eonia overnight rate is likely drift lower.”

The central bank expects the euro-region economy to shrink about 4.6 percent this year before returning to growth by the middle of 2010. Loans to the private sector declined for a third straight month in May as banks tightened lending standards and demand for credit wilted.

‘No Guarantee’

“While the ECB’s liquidity support to euro-zone banks sounds the right thing to do, as bank lending is by far the most important source of financing for euro-zone non-financial firms, there is no guarantee that banks will use this extra liquidity to lend to the broader economy,” said Daniele Antonucci, an economist at Capital Economics Ltd. in London.

The Organization for Economic Cooperation and Development said today the ECB should quickly cut interest rates toward zero and commit to keeping them there for as long as needed to revive the economy.

While President Jean-Claude Trichet has not closed the door to further reductions, Germany’s Axel Weber said yesterday the bank has used up its room for rate cuts and Austria’s Ewald Nowotny said in a June 19 interview that borrowing costs are likely to remain at their current level into 2010.

“If financial institutions judge that interest rates are now likely to have troughed in the euro area, this operation represents possibly the final opportunity to obtain 12-month funding at just 1 percent,” said Colin Ellis, an economist at Daiwa Securities SMBC Europe Ltd. in London.

Weber said yesterday he expects the 12-month loans to “lead to a further narrowing of spreads” on longer-term market interest rates. Demand for shorter-term ECB loans may wane as a result of the new auction, he said.

The ECB’s allotment of 7-day loans to banks yesterday fell to the lowest amount since Lehman Brothers Holdings Inc. filed for bankruptcy nine months ago.