Yesterday the European Central Bank grabbed the headlines by lending Euro 529,000,000,000 to 800 European commercial banks for three years. This was a top up to the Euro 489,000,000,000 they had lent for three years one month last December for 1% per annum to 523 banks. That makes a tidy One Trillion Euros of 3 year lending, all repayable January-February 2015.
That was not the only money they lent yesterday, They also lent Euro 134 billion overnight at 1%, Euro 29 billion for 7 days at 0.26%, and Euro 6.5 billion for 3 months. Commercial banks also borrowed from the ECB $3.5 billion of 7 day money and $14.5 billion of 84 day money. The European Central Bank’s website also declares a stock of Euro 65 billion of purchased covered bonds at the same date.
What does this tell us? It confirms that the normal interbank market in Europe is still well and truly frozen. Banks are unable to borrow the sums they need from each other. It also tells us the banks see profitable opportunities to make some money on the back of very cheap three year loans. Even allowing for low official interest rates, and low returns on German government bonds, there is still a turn to be made barring capital losses.
This liquidity is helping drive down the costs of Spanish and Italian official borrowing, as they hoped it would. It has not had the same benign impact on Greece or Portugal. It does nothing directly to curb the large deficits, grow the economies or solve the tax problem in the most damaged southern states. It does buy them time, it does keep the interest charges down in the countries where some of the cash is used to drive government bond prices up and interest rates down as a result. The commercial banks could even consider lending more to the private sector for suitable projects, which could give the economies affected a modest boost.
The question is what do they use the time for that they are buying with this large injection of liquidity? They need to be repairing and sorting out the banks, so they can set up a working interbank market again. They need to be developing growth policies which work. The danger of the current system is that it means weak banks are propping up weak countries which are propping up weak banks. The Central Bank has taken various items as collateral for its loans. They need to mend the underlying economies to make sure the Central Bank can get its money back on time, and to ensure the collateral it has taken has full value.
If they do not restore health to bank and state finances, and growth to economies, this becomes a fanciful money go round which will go wrong.