Download On June 23 the ECB allowed European banks and

On June 23 the ECB allowed European banks and financial companies to borrow
unlimited amounts of cash from the central bank. The next day the ECB
revealed that over one thousand banks borrowed 442 billion euros ($618 billion)
in what is now the largest capital injection into the European banking sector since
the financial crisis began. The banks that took the loans will be required to repay
them with one percent interest, within one year.
The size and generous terms of the loans mean that Europe will not see massive
bank failures for the next year. In utilizing its substantial but narrow power to
extend unlimited amounts of credit, the ECB has buttressed the broader
European banking sector which [finds itself in a precarious state
(http://www.stratfor.com/geopolitical_diary/20090512_geopolitical_diary_europea
n_banking_crisis)]. Indeed, the record demand demonstrates just how serious of
a bind European banks are in. But while the loan will fix the immediate solvency
problems facing the banks, the [diverse manifestations
(http://www.stratfor.com/analysis/20090109_eu_challenge_financial_oversight)]
of each state’s banking woes will go unsolved.
The roots of this banking malaise are a combination of the global credit binge of
recent years and, ironically, euro currency adoption itself. Membership in the
eurozone afforded many once credit-starved economies the benefit of low
interest rates backed by Germany's robust economy. This allowed consumers in
Spain, Ireland and Italy to consume using cheaper-than-ever credit. At the same
time, many banks used low interest euro loans to offer consumers in [emerging
Europe
(http://www.stratfor.com/analysis/20090227_eu_rescuing_emerging_europes_ba
nking_system)] where they had subsidiaries foreign currency denominated loans.
Particularly active were Austrian, Italian, Swedish, Greek and Belgian banks. In
total, European banks lent out nearly 950 billion euros ($1.3 trillion) in emerging
Europe, which consists of Central European non-eurozone EU member states,
the Balkans and the Baltic States.
The implosion of the global market for U.S. subprime assets then triggered the
same banks to frantically bolster their balance sheets by withdrawing from these
risky markets, shifting funds into assets with a trusted sovereign guarantee such
as U.S. Treasury bills, and thus reducing the availability of consumer credit
throughout the region. As credit was withdrawn from emerging Europe,
consumers and businesses became unable to service the large amounts of debt
that built up. Assets backed by European consumer loans followed their
American brethren down in domino-like fashion. But while the American solution
has been a dynamic – and, importantly, a rapidly implemented – complex of
monetary, fiscal and regulatory measures, Europe finds itself hamstrung by a
patchwork of regulatory systems that [prevent a unified response
(http://www.stratfor.com/analysis/20090405_eu_0)] and ensure ongoing
problems in its financial sector.
This week’s infusion of credit is of course not unwelcome, following the ECB’s
June 2009 Financial Stability Review which estimates that European banks will
be forced to accept losses on an additional $283 billion in bad assets due to US
and EU consumers defaulting on mortgages and other loans. Based on an
estimate of $649 billion of bad assets for the entire financial crisis, this estimate
may paint too rosy a picture of the European banking sector. The IMF puts the
sum total at $904 billion, which means there could be over $500 billion in write
downs still to come. Interestingly, the 442 billion euros worth of loans just about
fits the IMF’s estimate of future bank losses, so although the ECB has called the
IMF estimate into question, the market has now leant a great deal of credence to
it.
And while the ECB credit will go a long way to ensuring that Europe’s banking
sector remains solvent – banks can essentially sit on the funds and pay 1% to
remain afloat for the next year – the hope is that the money will help to ease
credit availability. In theory the funds would bring banks well above minimum
reserve requirements – cash that is required to be kept readily available – and
free up excess funds for extending new loans. The need for bank loans is keenly
felt by European industry, which relies on more than double the amount of bank
loans than its American counterparts who routinely tap stock and bond markets
for capital. The ECB has helped to support Europe’s corporate bond market, by
agreeing to [purchase 60 billion euros worth of covered bonds
(http://www.stratfor.com/analysis/20090604_eu_ecb_outlines_its_bond_purchas
e_plan)], but as evidenced by its relatively small size, the purchases wont make
much of a splash in an economy largely reliant on bank loans.
It is far from clear however that even a massive cash infusion will restart credit
flows to businesses and consumers. Consumers in the US and EU, by many
measures, are not ready to ramp up spending. Demand for credit, from
consumer markets and the manufacturing industries that supply them, remains
depressed. In such environments [banks turn to other avenues
(http://www.stratfor.com/analysis/20090518_germany_failing_banking_industry)]
to generate profits. Already, anecdotal evidence is surfacing that banks are
looking to risky investments like [currency carry trades
(http://www.stratfor.com/analysis/20081015_hungary_hints_wider_european_cris
is)] to turn a profit.
While this injection of funds may not find its way into ailing consumer and
business markets, it will definitely be a huge boon to European banks formerly
sporting big holes in their balance sheets. However, without a pan-European
regulatory framework that aligns the fiscal policies of the EU’s varying
economies, the central bank’s monetary policy is nothing more than a temporary
fix.