Crisis fears ease as banks queue up for cheap funding

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the chances of a second credit crunch appear to have receded, for the time being, after banks lunged at the European Central Bank’s first-ever offering of three-year funding, taking up a huge 489 billion euros.

But policymakers’ hopes that the money will be used to buy Italian and Spanish bonds and ease the underlying sovereign debt crisis are more likely to be disappointed.

A total of 523 banks borrowed money at the tender with demand way above the 310bn euros expected by traders in the run-up to the operation.

The banks’ move for funding pushed the euro to a one-week high versus the dollar and sparked a rally in stocks.

The three-year loans are the ECB’s latest bold attempt to ease the eurozone’s troubles. It is the most the bank has ever pumped into the financial system, topping the near 450bn it injected with its first one-year loans back in 2009.

Its hope is that the ultra-cheap and ultra-long funding will have a range of beneficial effects, including bolstering trust in banks, easing the threat of a credit crunch and tempting banks to buy Italian and Spanish bonds, thereby calming markets and easing the currency bloc’s sovereign debt crisis.

“The take-up was massive and much higher than the expected 300bn euros. Liquidity on the banking system has now increased considerably,” said Annalisa Piazza at Newedge Strategy, adding that the take-up probably came largely from banks in the eurozone’s debt-laden states.

“In a nutshell, the three-year auction can been considered as successful in terms of adding liquidity to the banking sector,” she said.

While an interbank lending crunch may have been avoided, it is much less certain banks will use the money to buy Italian and Spanish government debt, as French President Nicolas Sarkozy has urged, given the competing pressures on them to cut risk, rebuild capital and lend to business.

“While this might help to address recent signs of renewed tensions in credit markets and support bank lending, we remain sceptical of the idea that the operation will ease the sovereign debt crisis too as banks use the funds to purchase large volumes of peripheral government bonds,” said Jonathan Loynes, Chief European Economist at Capital Economics.

Martin van Vliet, analyst at ING Bank, added: “We doubt whether the money will be used extensively to fund purchases of peripheral debt, given concerns about mark-to-market risks and possible reputation risks.”

Given those doubts, most market experts say only more aggressive and direct buying of government bonds by the ECB will help ameliorate the crisis, something it is reluctant to do.

ECB president Mario Draghi has been pressing banks to take the money since announcing the plans earlier this month.