Who is the ECB lending to?

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Is the European Central Bank propping up dodgy lenders? Since the credit crunch began, some observers have argued that the ECB’s lending policies are too generous and transfer banks’ private risks on to the public.

The numbers suggest worries may have been exaggerated. The ECB had €445bn of loans outstanding to eurozone banks in early April – just €1bn more than in April 2007 and almost a third below January’s peak. Research by Fitch Ratings shows this is 1.6 per cent of total eurozone banking system assets.

True, banks are borrowing for longer. The longer-term refinancing operations (between three and six months) offered by the ECB now represent more than half of total ECB lending, up from a third in March 2007. Structured products such as asset backed securities (ABS) make up nearly a fifth of the collateral provided by banks to the ECB – against 4 per cent in 2004. Safe government bonds have fallen from \above 30 per cent to 17 per cent.

Spain and the Netherlands, accused of exploiting the ECB’s generosity, are responsible for much of the use of ABS (including mortgages) as collateral. But these countries’ share of total ECB lending is fairly small. Spain’s banks account for nearly a 10th of eurozone banking assets and 9 per cent of total ECB lending. The Netherlands borrows even less. Germany remains the biggest user of ECB facilities. Its borrowing has been fairly stable over time.

There are legitimate concerns. It is unclear how much of eurozone banks’ borrowing is on behalf of banks outside the region – UK banks, for instance. Potentially, banks could be holding on to more liquid assets while using riskier assets as collateral for the ECB. The central bank applies its own valuation models to assets it receives as well as demanding a haircut. It can also require banks to replace collateral if its quality deteriorates. As yet, there is no evidence it has done so.

The ECB’s decision last autumn to increase its lending and loosen some of the terms of such lending looked risky. Its gamble, so far, appears to be paying off.

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