Tags: EU | Europe | Financial | Crisis

Nervous European Banks Stash Money With Central Bank

Friday, 23 Dec 2011 10:32 AM

Banks from the 17 countries that use the euro stashed 347 billion euros ($453 billion) overnight with the European Central Bank on Thursday, in another sign that Europe's debt crisis is still putting pressure on the banking system despite massive central bank support.

The figure announced Friday is the highest for 2011, topping 346.4 billion euros earlier this month.

It's a sign of mistrust in the interbank lending market where banks raise operating funds, suggesting they are depositing money with the central bank at low interest rates because they are afraid to lend it to other banks — for fear they won't get paid back.

Europe is suffering from a debt crisis marked by concerns that heavily indebted governments such as Italy may be unable to pay off their bonds. That means trouble for banks because they typically hold government bonds.

The large deposits come despite Wednesday's massive central bank credit operation, in which the ECB let banks borrow as much as they wanted for up to 3 years. As a result 523 banks took 489 billion euros, the largest ECB loan operation in the 13-year history of the euro.

The European Central bank has stepped up lending to banks to help them get through the crisis. Some of the banks are finding it extremely difficult to raise money elsewhere, so the bank steps in as lender of last resort, a typical role for central banks in times of turmoil.

The bank has refused to play the same role for governments by buying large amounts of their bonds, saying they must get their debts under control through their own efforts and not wait for a central bank rescue.

It underlined that stance again by revealing Friday that it held down its purchases of government bonds to only 19 million euros this past week. The ECB has been buying government bonds on a limited scale, which has helped drive down the borrowing rates that Italy and Spain face in the bond market.

But it says the program is not infinite and that governments must not rely on central bank efforts to lower their borrowing costs. That must be down, ECB head Mario Draghi says, by getting deficits under control and taking steps to improve growth.

It bought a minimal 3.36 million euros last week. That makes two weeks of near-negligible purchases, following 635 million euos the week ending Dec. 9 and 3.66 billion euros the week ending Dec. 2.

Italian 10-year bond yields remained elevated Friday at 6.85 percent, another sign that the markets remain fearful of a default by the eurozone's third-largest economy. Before the crisis spread to Italy, it was able to borrow at under four percent as recently as October 2010.

European governments are trying to win back the confidence of bond market investors by reducing deficits, a difficult job in a slowing economy. Italian Prime Minister Mario Monti won approval Thursday from the Italian Senate for 30 billion euros in additional cutbacks and revenue increases.

Greece is working on a deal to cut its debt by making bondholders accept a bond exchange that would mean a 50 percent reduction in the value of their investments. The bondholders could accept that instead of the larger losses that would come from a disorderly default not agreed in advance.

A top ECB policymaker said in an interview published Friday that the central bank could use its power to create new money to buy financial assets if a deteriorating economy threatens the eurozone with deflation — falling prices.

Lorenzo Bini Smaghi, who is leaving office next week, was quoted by the Financial Times as saying he saw "no reason" why the bank could not use the technique, called quantitative easing by economists. Both the U.S. Federal Reserve and the Bank of England have used it after lowering interest rates to record low levels and finding that their economies still needed more stimulus.

The ECB's mandate is to provide price stability, so fighting deflation could be consistent with that. At the moment, however, inflation is running at 3.0 percent, well above the ECB's goals of just under 2 percent.

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