European Banks Take Action on Crisis Era Loans

At this time last year, European financial institutions were desperate for funding, as financial markets were volatile and many banks, especially those peripheral countries such as Spain and Italy, were shut out of the credit markets. To prevent a full-blown crisis, the European Central Bank instituted a loan program known as LTRO, whereby banks could post collateral to borrow an unlimited amount of capital from the ECB at a 1% interest rate. News out late last week points to a vast improvement in funding markets, with many banks repaying these 2- or 3-year loans early. While the ECB didn't provide a breakdown in loan repayment by bank or country, the WSJ writes that roughly one-third of the money that was repaid came from Spanish banks, which were at the center of the turmoil last year. What these euphoric news stories fail to point out is that many banks repaying these loans are then going back to the ECB and borrowing from the short-term window, a program where banks can borrow an unlimited amount for periods of overnight to 3 months. The rates on these loans are well below the 1% on loans from the LTRO program, creating an economic incentive to repay LTRO loans early. Perception may be another reason for repaying the loans early, as it indicates to investors that they are healthy, similar to what US banks did after receiving TARP money a few years ago. While LTRO repayment is certainly a positive and signals some relief in credit markets, we remind our readers that many of the Eurozone’s problems are far from solved, and hidden toxic assets are still present on bank balance sheets. The risk is that, in a recessionary environment like the Eurozone is currently facing, these assets will need to be written down further, causing bank capital adequacy questions to be asked once again. Political questions are also unanswered, such as how long Germans are willing to support their southern neighbors, and how long Spain can continue to have 25%+ unemployment and still push through painful austerity measures.