25 February 2013

FT: Loans payback points to divided eurozone

The ECB revealed that 356 of the 800 banks that took the second round of cheap funds offered under the ECB's three-year longer-term refinancing operations a year ago had decided to make an early repayment.

The big question is what early repayment says about the state of Europe’s banks. Mario Draghi, ECB president, has sought to reverse the “fragmentation” of Europe’s monetary union – the retrenchment of weakened banks behind national borders – which has added to the squeeze on lending to households and businesses.

On one hand, the fact banks are now paying back the €1 trillion pumped in to the financial system is a significant sign of how much has changed in the past year. The LTRO helped stave off a liquidity crisis looming over the region’s banks. It enabled lenders to issue again and was a factor in the wider recovery in financial markets. Delve further into the LTRO and economic data, however, and a picture of a two-tier or even three-tier Europe resurfaces.

Of the lenders that have announced early LTRO repayments, most are northern European lenders such as Commerzbank, KBC and Société Générale. Northern European banks largely used the LTRO as an insurance policy in a period of stress. Since Mr Draghi promised to do “whatever it takes” to save the euro, these banks no longer need or want the cheap central bank loans given it is more efficient to tap low-cost funding in public debt markets.

In southern Europe, it is a different story. Spanish and Italian lenders were the biggest users of the LTRO. National champions in both countries, as well as Portugal and Ireland, have seen strong demand for recent bond issues.

What is noticeable is that while large Spanish lenders such as BBVA and Santander have signalled that they are repaying, many second-tier banks are not. There is also no indication that Italian banks have made any repayments so far, although uncertainty surrounding Italy’s elections may have led some banks to postpone handing back the LTRO money. But such reticence makes sense and may not necessarily be worrying. Many southern European banks used the LTRO to play the “carry” trade, borrowing cheaply to invest in government debt. Holding on to the money, therefore, is still attractive for them.

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