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S&P: ECB Loan Reduces Liquidity Risk, Underlying Structural Issues Remain

Standard & Poor's Ratings Services Wednesday said the European Central Bank's second unlimited three-year loan has reduced the risk of liquidity-driven bank failures, and also provides banks time to adjust their business models. Nonetheless, S&P's report states the long term refinancing operation by ECB has not addressed the underlying structural issues in the banking sector.

Earlier, the European Central Bank pumped in huge amount of funds for its long term refinancing operation to help European banks. The second ECB three-year Long Term Refinancing Operation made available to banks a record euro 529.5 billion, or $712.4 billion, in an effort to alleviate capital concerns. Economists expected funding between euro 470 billion to euro 500 billion.

"We believe that the ECB's intervention has materially reduced the risk of a liquidity-driven bank failure, and averted the possibility of a severe credit crunch and additional recessionary pressure across the Economic and Monetary Union (EMU or the eurozone)," S&P said in a statement.

Nevertheless, S&P said the ECB actions does not address the underlying structural issues in the banking sector, such as capital shortfalls at various banks, the questionable viability of some business models in the medium term, and continued uncertainty over the appropriate carrying values of assets such as certain sovereign exposures.

In the first offering of 3-year loans in December 2011, the ECB shelled out euro 489.19 billion at 1 percent interest, which helped cash-strapped lenders to refinance maturing bonds.

While economists expect the operation to provide further vital support for the eurozone's beleaguered banking sector, they are apprehensive if it would alter the underlying outlook for the wider economy or bring an end to the peripheral debt crisis.

As such, S&P sees another challenging year as banks continue to deleverage, divest or close its non-core business, recognize problem assets, and accumulate capital through various means.

The rating agency indicated that the ECB intervention has alleviated the immediate concern of refinancing risk, while providing banks with "more time to adapt their balance sheets and strategies to the new market and regulatory context." Nevertheless, the agency cautioned that the banks are faced with an onerous task, given the challenging economic and market conditions prevailing.

The second ECB loan offering saw a sharp increase in the number of banks bidding for the long-term funds from December. The second offering had 800 banks participating, up from 523 banks in the December operation.

The broadening of the pool of collateral allowed more small and medium sized banks to tap the special three-year funding scheme. Analysts also believe the increase in participants could indicate fresh demand from banks that did not participate in the first offering, on consideration for their reputation. Nevertheless, it is evident that such banks now see the offer attractive with benefits outweighing the disadvantages.

The cheap loans are offered to banks so as to restrain them from curbing loans to businesses and consumers as well as to ease fears of banks running out of money. Thus far, instead of lending, banks were parking additional funds at the central bank.

by RTTNews Staff Writer

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