LTRO Helps Euro Banks

Vidrum / 01 Mar 2012

The Long Term Refinancing Option (LTRO) has become a saviour for the Euro zone. Recently, the European Central Bank (ECB) made 530 billion Euros available to the cash strapped Euro zone banks.
The Long Term Refinancing Option (LTRO) is in the news nowadays, as it has granted temporary relief in the European sovereign debt crisis and has become a saviour for the Euro zone. Recently, the European Central Bank (ECB) made 530 billion Euros available to the cash strapped Euro zone banks. This is the second time the ECB is helping the European banks, after having issued approximately 489 billion Euros in Dec 2011.

The LTRO granted by the ECB to the banks are for a duration of 3 years at a nominal rate of 1%. This option helps the Euro zone banks to solve their near term liquidity issues and avoid a default in payments.

The newly issued funds to the banks through the LTRO would probably be used for repayments of dues, expansion activities and for maintaining their capital requirements. The funds issued earlier in Dec 2011 were majorly used to repay their loans. The Euro banks had converted their short-term debts to long-term ones. 

This second LTRO will create additional liquidity in the system. This LTRO is being compared to the Quantitative Easing (QE) that was done by the US. The QE helped the US economy to revive, and the LTRO would also probably do the same for the Euro zone to some extent.

With the banks getting funds at a cheaper rate, it is expected that they will now be able to fulfill their obligations smoothly. This has resulted in the bond yield moving southwards. Earlier, there were concerns about whether the banks will be in a position to pay their dues, which had resulted in the yield moving northwards. The sentiment in the Euro market was also positive, which gave some relief to the liquidity-affected Euro zone.

We, at DSIJ, believe that this liquidity infusion to the Euro banks will only be a temporary relief and it does not solve the underlying sovereign debt crisis. The funding was above the market expectations, which led to a positive sentiment in the Euro zone. There are still no definite solutions in sight for the sovereign debt crisis and the growth of the European economy, and it may be some time before one can safely think that the worst is over in the Euro zone.

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