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Questions and answers on the European Central Bank's second issue of emergency loans to banks
The European Central Bank issued its second raft of three-year, low-interest emergency loans to the financial sector, handing out euro529.5 billion ($712 billion) to 800 banks on Wednesday.
Here are some questions and answers on the latest move to ease the European debt crisis.
Q: What are these loans for?
A: The ECB decided in December 2011 to offer these loans to make sure European banks have enough cash on their balance sheets to deal with a tightening credit market. Uncertainty over banks' potential losses to weak government bonds, such as Greece's, caused banks to stop lending to each other. Because banks depend on that cash to fund everyday operations, the ECB's loans restore confidence in the wider financial sector.
The hope is that the banks will also use the cash to increase loans to businesses and households, boosting economic activity.
Q: Do the loans work?
A: The loans are widely credited with having eased tensions in Europe's debt crisis. Banks that borrowed from the ECB's first tender of emergency loans in December appear to have invested in the government bonds of countries like Italy and Spain. That has caused those countries' borrowing rates to drop sharply ' bond yields drop as the bond price rises. Stock markets have also rallied.
However, there is little evidence so far that the banks have stepped up lending to businesses and households, which is necessary for a lasting economic recovery. In fact, many eurozone economies are predicted to fall back into recession.
Q: Will the emergency loans be enough to solve the debt crisis?
A: No. The loans have avoided a new credit crunch and could increase the supply of loans to the economy, according to the ECB, but the 17-country eurozone has deeper, structural problems. The loans support a credit market ' lending between banks ' which should work normally on its own. Analysts say the emergency loans essentially buy the eurozone time to fix problems such as excessive debt, trade imbalances and lack of economic competitiveness.
Q: Is it risky for the ECB to issue such huge amounts of loans?
A: The ECB demands collateral for the loans, so it is technically covered in case any banks go bust and are unable to repay the ECB.
Some officials, particularly German central bankers, have warned that issuing too many of these loans could push banks to speculate on certain investments, potentially creating asset bubbles or stoking inflation. Critics also warn that easing borrowing rates for countries like Italy and Spain could reduce incentives for their governments to implement tough austerity measures.
Q: The ECB already has a bond-buying program to help ease the debt crisis. How are these loans different?
A: The ECB was never comfortable with its bond-buying program, in which it purchases governments bonds of countries like Italy and Spain to push their market borrowing rates down. That's because it is illegal for the ECB to offer direct support to a government.
By offering the loans to banks, however, it can offer indirect support by loading banks up with cash to invest in assets such as government bonds.