What Will Banks Do With €530B in Cash?

Euro-area banks borrowed a record amount of three-year cash from the European Central Bank on Wednesday, taking advantage of an operation that is meant to ease the effects of a credit crunch stemming from the debt crisis and boost bond and equity markets.

The ECB said today it will lend 800 financial institutions a combined total of 529.5 billion euros for 1,092 days. In the ECB’s first three-year operation in December, 523 banks borrowed 489 billion euros.

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The sheer volume of banks borrowing this year indicates that a lot more small banks looked for money “and it is likely they will pass it on to the economy,” said Laurent Franselot, head of income strategy at Barclays Capital in London. “So the impact may be bigger than with the first one.”

Bond and equity markets have rallied since the first three-year loans, known as LTROs, were dispersed in December, suggesting banks are investing at least some of the money in higher-yielding assets, and helping to ease concern about a credit crunch. However, the risk is that banks may become too reliant on ECB money and fail to take necessary steps to strengthen their balance sheets.

Banks used a big chunk of the 489 billion euros they borrowed in the first round to cover maturing debt, and have been parking close to half a trillion euros at the ECB in overnight deposits. After the first operation, ECB President Mario Draghi said that “a major, major credit crunch” had been averted.

Now Draghi is urging banks to lend out the funds they tap in the second operation to households and businesses to help strengthen local economies. ECB officials also hope banks will use the money to buy higher-yielding bonds more aggressively, especially from countries like Italy and Spain, where borrowing costs have been high.

Evidence suggests banks, especially those in Spain and Italy, have been using the funds to pursue so-called “Sarkozy trade” — a term markets coined after the French president suggested governments encourage banks to buy sovereign debt. Spanish banks bought a net 23.1 billion euros of government debt last month, and Italian banks bought 20.6 billion euros, both record increases.

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To contact the reporter on this story: Emily Knapp at staff.writers@wallstcheatsheet.com

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