The LTRO in perspective
0As widely reported, banks in Europe borrowed €530bln gross (€310bln net) from the ECB in Wednesday’s three-year LTRO tender, and this was a bit more than consensus expectations.
This injection of term liquidity with very lenient collateral standards has vastly improved funding conditions for European banks and, for the time being, has largely taken the risk of an uncontrolled deleveraging off the table. Spanish, Italian and other periphery banks have used cheap three-year ECB loans to fund roughly €75bln of sovereign debt purchases to date (3% of GDP, 1.5 months of sovereign gross funding needs and nearly 70% of their net 2012 borrowing needs), with more almost certain to come following Wednesday’s tender, compressing spreads particularly in the front end of the curve, where banks can put on matched-maturity carry trades using ECB funds.
However, longer-term imbalances remain unresolved, so the periphery’s ongoing dependence on foreign capital remains substantial and the sustainability of demand for these bonds is suspect given lenders’ existing high level of exposures. The LTRO substantially reduced banks’ funding risk, but increased the risk of their asset portfolios. Given the lingering imbalances, additional official support will likely be necessary once this surge of liquidity clears the system.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
