ECB hands out $712 billion in loans to banks

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By DAVID McHUGH, Associated Press

FRANKFURT, Germany (AP) — The European Central Bank's second offering of unlimited low-interest loans was gobbled up Wednesday by 800 banks, who borrowed euro529.5 billion ($712.4 billion). More than euro1 trillion has been pumped into Europe's financial system in this way in just over two months in an attempt to stabilize banks, governments and businesses.

The first offering on Dec. 21 attracted 523 banks to borrow euro489 billion ($657.9 billion) and helped ease the eurozone debt crisis because banks used some of the money to buy government bonds. That helped lower the borrowing costs of heavily indebted countries such as Italy and Spain and gave investors confidence that Europe was getting control of a government debt crisis that has lingered for more than two years.

How the banks deploy the money this time is an open question, although the ECB enticed more smaller banks to participate in the hope that they would help boost the eurozone economy by lending to small- and medium-sized businesses. ECB President Mario Draghi assured bankers there was "no stigma" associated with borrowing from the central bank — an effort to convince those who feared it would make their financial institutions look desperate in the eyes of investors.

The three-year ECB loans, given against collateral such as bonds or other securities, cost banks 1 percent.

Analysts had expected slightly less demand for the loans this time. The market response was muted, with the Euro Stoxx 50 index up 0.60 percent and the euro off 0.2 percent at $1.3442 in afternoon trading in Europe. The interest rates on some European government bonds, including Italy's, fell.

The ECB's first round of ultra-cheap loans helped relieve the pressure on hard-pressed governments such as Spain and Italy, which had been struggling to maintain large amounts of debt.

Banks used the ECB loans to buy government bonds that carried a higher interest rate than the central bank's loans. The added demand for the debt helped raise bond prices — and lowered the yields, which move in the opposite direction. That eased borrowing costs for indebted governments and thereby calmed fears of a looming market meltdown.

With more financial breathing room, the new governments of Spanish Prime Minister Mariano Rajoy and Italian Prime Minister Mario Monti have time to push for reforms aimed at making their economies more productive. That should increase growth and tax revenues, but the measure will take years to take effect.

The burst of cash also removed fears that a European bank might collapse because it couldn't pay off bonds or other debt coming due. European banks faced some euro230 billion in bonds coming due in the first quarter, and much of the money went to pay off those obligations.

Following the first batch of ECB loans, bank funding markets that had been frozen began to thaw, as some banks were able to borrow by issuing bonds.

On Wednesday, yields on Italian bonds fell 10 basis points to 5.17 percent by late afternoon trading in Europe. The yields had been over 7 percent late last year that pushed Greece, Ireland and Portugal to seek bailouts.

Several analysts said the ECB's latest action was unlikely to provide much more relief to governments.

"Given that there are no further tenders scheduled and the recent ECB rhetoric has been skewed toward this being the last, we believe the market will return to fundamentals and move away from this liquidity euphoria," analysts at Royal Bank of Scotland wrote in a research note.

The larger number of banks in this round of loans follows ECB steps to widen the circle of borrowers to smaller banks, typically the ones who lend to small and medium-sized busineses — which provide most of the jobs in the euro area. The ECB permitted a wider range of collateral to match what smaller banks might be able to put up.

The banks were not identified, and it remains an open question whether the money will reach the wider economy in the form of more loans. Much of the liquidity in the banking system continues to wash back to the European Central Bank in the form of overnight deposits as banks wait to deploy it — or simply hoard the money.

There are also concerns that the ECB is incurring unnecessary risk by lending to banks that can't borrow anywhere else. The ECB cannot lend to insolvent institutions, but it's not always easy to tell who is insolvent and who isn't. European Union regulators are pushing banks to raise more capital to thicken their financial buffers against possible losses from the debt crisis.

While they have steadied markets, the ECB loans have been less effective in stimulating bank lending to the wider economy. Loans to businesses only stabilized in January after a steep fall in December. Central bank officials are watching closely to see if their efforts result in more bank lending.

Sony Kapoor, managing director of the Re-Define think tank in London, said that whether the banks use the low-interest loans to invest in high-interest assets "or to lend more to the real economy will strongly shape what direction the crisis take next."

Peter Praet, a member of ECB's six-person executive board, has said the bank faces a difficult decision about whether to make more cheap loans available. ECB governing council member Ewald Nowotny has said he sees no need for further action after the second installment of loans.

Jens Weidmann, the head of the conservative Bundesbank, Germany's central bank, has warned that overly generous liquidity could lead to banks investing in riskier assets and that the crisis cannot be solved "solely by throwing money at it."

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