Thursday, April 12, 2012

Europe's banks beached as ECB stimulus runs dry

'There has been no transfer of risk to the ECB's own balance sheet, which is what we think is needed to take away the tail-risk of another EMU blow-up' Photo: Alamy

By Ambrose Evans-Pritchard

8:19PM BST 11 Apr 2012

The European Central Bank's €1 trillion (£824bn) lending spree over the winter has stored up a host of fresh problems, leaving parts of the banking system more vulnerable than before as the short-term "sugar rush" nears exhaustion.

Credit experts say the Spanish and Italian banks are trapped with large losses on sovereign bonds bought with ECB funds under the three-year lending programme, or Long-Term Refinancing Operation (LTRO).

Andrew Roberts, credit chief at RBS, said Spanish banks used ECB funds to purchase five-year Spanish bonds at yields near 3.5pc in February and 4.5pc in December. The same bonds were trading at 4.77pc on Wednesday, implying a large loss on the capital value of the bonds.

It is much the same story for Italian banks pressured into buying Italian debt by their own government. Any further dent to confidence in Italy and Spain over coming weeks – either over fiscal slippage or the depth of economic contraction – could push losses to levels that trigger margin calls on collateral.

"The banks are deeply underwater. This is turning into a disaster for the eurozone periphery now that the liquidity tap has been turned off," said Mr Roberts. "But given the opposition in Germany, the ECB can't easily do another LTRO until there is a major crisis."

Spanish banks bought €67bn of sovereign debt between December and February, while Italian banks bought €54bn. The purchases almost certainly continued in March. These lenders have soaked up most of debt issues in their countries over the past three months, picking up at a juicy return under the "carry trade" while at the same acting as a conduit for the ECB to shore up crippled countries by the back-door.
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