Wednesday, December 7, 2011

The not so "secret" ECB lending efforts

With the all the hoopla about the "secret" loans to US banks during the 08 crisis, there doesn't seem to be the same level of scrutiny on the ECB's current support for European banks. In dollar terms the amount outstanding to European institutions is over 3/4 of a trillion and growing. This shows increasing dependence of European institutions on the central bank for short-term funding. The ECB is also considering easing collateral requirements (as banks run out of eligible collateral) as well as adding 2-year loans to allow banks to lock in term funding.

ECB lending to Euro-area banks in Billion EUR (Bloomberg)

There are other forms of support from the ECB.  To add liquidity to the systems the ECB continues to purchase covered bonds as part of their second "mini-QE" program.  The idea behind covered  bonds is to supposedly avoid taking on sovereign risk directly.

 ECB Covered Bond Purchase Program # 2 (source: ECB)

To address European banks' continuing need for dollars the ECB keeps tapping the Fed's Liquidity Swap Facility (chart below).

These efforts from the central banks, combined with the Fed's move to cut dollar borrowing costs on this facility, has reduced the EUR/USD Currency Basis Swap spread quite dramatically.

3-month EUR/USD Basis Swap Spread (Bloomberg)

But tightness in term dollar interbank funding continues to persist with USD LIBOR grinding higher.  This is particularly noticeable in the 3-month TED spread (LIBOR to T-bills):

3m TED Spread (Bloomberg)

Based on this, one should fully expect to see the ECB do more (not so "secret") lending and continuing to come up with innovative ways to keep the euro-zone banking system afloat.
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