European banks essentially rejected the European Central Bank on Thursday by declining its offer of a fresh round of virtually interest-free money, calling into question the latest effort to jumpstart the struggling euro zone economy.
The ECB said Europe’s banks withdrew €82.6 billion ($106 billion ) from the central bank in the first step of President Mario Draghi’s new effort to inject as much as €1 trillion into the euro zone economy. The number was a major disappointment to investors, who had been expecting banks to take up about €150 billion according to a Bloomberg survey.
The low uptake is “a clear disappointment after Draghi had said the ECB was aiming to expand its balance sheet considerably,” according to Jan von Gerich, a strategist in Helsinki for Nordea bank. He added that the low uptake means the markets are now likely to pay much closer attention to December, when banks will have their next opportunity to draw funds from the ECB.
At stake for the ECB is the revival of the euro zone’s sagging economy and preventing a dangerous spiral of deflation – falling prices – across the currency bloc. Euro zone growth was flat in the second quarter of this year, and most economists expect the economy to grow by less than 1 percent over the whole of 2014. Inflation stood at an annual rate of 0.4 percent in August, dangerously close to zero and well below the ECB’s own target of close to 2 percent.
Germany has been skeptical that the plan will actually revive lending to the real economy, and its banks are unlikely to have been the main recipients of the ECB’s money. Most of the money was likely to be taken up by banks in the euro zone’s southern “periphery” of Spain, Italy, Greece and Portugal, which continue to struggle with low growth and high government debt.
“It remains uncertain whether the [ECB’s] long-term tender will result in more loans being handed out,” Michael Kemmer, head of the German banking association Bankenverband, told Handelsblatt.
Thursday’s announcement fulfilled a promise first made by ECB President Mario Draghi in June – and stepped up again in September – to do whatever he can to revive lending to European small businesses that have struggled to get loans from banks. Bank lending to the private sector has been falling every month since July 2012.
Mr. Draghi’s efforts have met some resistance in Germany in particular, where some have argued the Frankfurt-based central bank has overstepped its mandate. The ECB’s plan will be carried out through a series of programs that will either see the ECB give banks fresh loans, or actively purchase asset-backed securities and remove them from the balance sheets of banks. It is a massive project that the ECB hopes will convince markets it is serious about reviving the euro zone’s flagging economy.
“It remains uncertain whether the [ECB’s] long-term tender will result in more loans being handed out”
ECB President Draghi in September said he wants to swell the ECB’s balance sheet to levels last seen in early 2012, which analysts have estimated would mean injecting as much as €1 trillion into the economy, bringing it up to €3 trillion in total. The ECB has said the lending program launched Thursday – known as a Targeted Longer-Term Refinancing Operation or TLTRO – is the key plank of its effort to boost its balance sheet.
While Thursday is not the end of the line, the low uptake is “going to continue to suggest to the markets that the ECB may need to do more than they have,” Nick Matthews, senior European economist in London for the Japanese bank Nomura, told the Handelsblatt Global Edition in a phone interview.
Banks in Germany are not necessarily for want of cash on hand. Quite the opposite – banks say they would happily hand out loans, but argue that demand from companies is extremely low. The situation remains different in southern Europe, where many banks are still dependent on cheap cash from the ECB. Spain and Italy are likely to draw the most money.
The ECB has done everything it can to convince banks to participate in the program. Low interest rates, reduced further in September, mean banks can borrow the funds at a fixed interest rate of just 0.15 percent for four years. The catch is that they have to prove they have increased overall lending to the real economy- the amount they can borrow from the ECB is directly tied to the size of their loan books – but analysts said the ECB has still been pretty lax on its terms.
“It’s a scheme that’s deliberately designed to be very generous and incentivise take-up,’” said Mr. Matthews of Nomura.
The ECB has also brought its deposit rate into negative territory at -0.2 percent, meaning banks actually have to pay the central bank to park any excess reserves with the ECB. This, too, is designed to force banks to put any money they take from the ECB to work, rather than leave it in reserve.
“It effectively sends a message to banks: ‘you need to do something with this funding,’” Mr. Matthews said.
Thursday marked only the first opportunity for banks to borrow money under the ECB’s program. The next opportunity will come in December, followed by more chances to borrow money next year. Most analysts expect demand to be higher in December. Some banks may have held back this month as the ECB is still in the middle of a major “stress test” examination of the quality of European banks’ assets. The ECB also plans to announce the details of its new plan to buy up asset-backed securities in October – some banks may be waiting to hear those details first.
“I don’t think this is the most important allotment opportunity,” said Jana Meier, an economist in Frankfurt with HSBC-Trinkaus, the German subsidiary of British bank HSBC.
Banks also still have money left over from previous loan programs launched by the ECB in 2012 – analysts said they will be watching to see how much of this money banks will return at their next opportunity on Friday. If they return a lot, it means the ECB will have expand its balance sheet by far less than even the €86.2 billion they lent out on Thursday.
Either way, Thursday does mark the start of a make-or-break period for the ECB. The central bank will be watching closely over the next few months to see if there are any signs of success. If not, there is only one step left for the ECB to take: buying up government bonds, a program knwn as “quantitative easing” that remains massively controversial, especially in Germany.
“That is the last tool on the shelf,” Ms. Meier said. “After that, the ECB will be running out of options.”
Christopher Cermak is an editor with the Handelsblatt Global Edition in Berlin and Frank Drost is a financial correspondent for Handelsblatt in Berlin. To contact the authors: email@example.com; firstname.lastname@example.org