Banks will repay more than €130-billion ($184-billion U.S.) of crisis loans to the European Central Bank next week, handing more cash back early than expected in a sign at least parts of the financial system are returning to health.
The ECB made over €1-trillion of ultra-cheap three-year loans to banks in twin lending operations in December 2011 and February 2012 – a move ECB President Mario Draghi said had “avoided a major, major credit crunch”.
The euro zone’s central bank said on Friday that 278 banks would repay a total €137.2-billion of the December loans at the earliest opportunity on Jan. 30, although it did not name them. A total of 523 banks tapped the first of the two long-term loans, known as LTROs, just over a year ago.
German debt prices fell and banking stocks and the euro rose on news of the early repayment, which exceeded the €100-billion forecast in a Reuters poll of traders. Banks can repay the money early on a voluntary basis weekly from now on. Repayment of the second LTRO starts on Feb. 27.
“This exceeded expectations, I expect the pace to slow down considerably in the next week,” said Nordea analyst Jan von Gerich. “Quite a few stronger banks paid back as soon as possible, whereas weaker banks took money in the second LTRO.
“I don’t think that repayments will reach a level where overnight interest rates will start to move up,” he added.
The large early repayment will be welcome news to some ECB policy makers, who were concerned about the increased risks the central bank carried on its balance sheet with the loans.
German Chancellor Angela Merkel said at the World Economic Forum in Davos, Switzerland on Thursday: “It will be important for Europe as well that the ample liquidity that was given out to banks last year is collected back again.”
Banks generally borrowed cash for three reasons: as an insurance policy in case the euro zone crisis worsened and left them short of liquidity; as a “carry trade” to finance purchases of higher yielding government bonds; or to fund their loan books if they were struggling to access cheap funding.
Spanish and Italian banks were among those which ploughed the money into their own countries’ sovereign bonds, yields on which were then at record highs but have since tumbled as a result of the ECB’s loans and its September bond-buying pledge.
They were seen as less likely to pay back the cash at the earliest opportunity, preferring instead to keep holding bonds on which they are likely to have made big profits as the euro zone crisis has eased.
Major banks who took the loans as an insurance policy are most likely to repay early. Paying back is a badge of honour for banks anxious to impress investors and rating agencies and distance themselves from more cash-strapped rivals.
Some, however, may risk overstretching themselves in their eagerness to do this. There is also concern that early repayment could highlight a two-tier system and see stigma returning to banks who not choose early repayment, bankers said.
“Circumstances have changed,” said Chris Wheeler, analyst at Mediobanca Securities. “Banks have shrunk their balance sheets, and at the time they took the cash for many it was a belt-and-braces approach to make sure they had a buffer in place. Now they don’t need it.
“We possibly have a situation now where it’s more of a stigma than it was to be holding the money.”
Benoit Coeure, in charge of market operations on the ECB Executive Board, sought to allay such concerns last Friday by playing down the chance of banks repaying a massive chunk of their LTRO cash this month.
Mr. Coeure also said excess liquidity in the euro zone remained very high. Reuters calculations show there is around €583-billion more money in the market than is required for it to operate effectively.
“It is important to keep in mind that there is still plenty of excess liquidity out there,” said Frank Oland Hansen, economist at Danske Bank. “Short rates are going higher, but it is still quite a moderate reaction.”