The news has been coming out that 287 banks will repay some $185 billion in ECB LTRO funds in the coming weeks. This is welcome news for the market and dodges a serious bullet that we thought could occur at the end of three year collateral window if banks were not on more solid ground.
As we noted early last year in articles and reports, we were concerned that the build-out of lower quality collateral at the ECB could, after its three year expiration, get flooded back into the market. This would have created a time-bomb situation that would have forced banks to again to suddenly deal with a large quantity of collateral that no one wanted. This could also have pushed banks to use more of their high quality collateral and run into a destabilizing Dexia-like dilemma.
The good news is it seems that the biggest concern of the LTRO is now being avoided. According to a January 25 2013 article by Stefan Riechter at Bloomberg, “‘The ECB is taking back some of the extra liquidity it injected into the banking system a year ago,’ said Christian Schulz, senior economist at Berenberg Bank in London. ‘This is a stark contrast to other central banks such as the U.S. Federal Reserve, the Bank of England and the Bank of Japan, who are still blowing up their balance sheets. No wonder that the euro exchange rate is going up.’”
We think this is a big deal for Europe’s financial sector stability. The more that banks are able to manage their lower quality collateral on their own balance sheets, the more confident counterparties and consumers will feel in doing business with them.
Already the US money market mutual fund industry has increased its exposure to European banks by more than 70% since June 2012, according to analysis released by Fitch today. Fitch also said that MMF holdings in Eurozone assets “now represent 12.9% of MMF assets. However, Fitch notes that MMF allocations to Eurozone banks remain more than 60% below end-May 2011.” You can’t win them all.
The goal for 2013 is more stability, which will support more LTRO repayments and further stabilize the banking sector. As ECB President Mario Draghi said in a speech last week, “Despite the good progress so far showing that adjustment is happening, reform efforts need to be sustained. Adjustment is inherently difficult and will remain with us for some time to come. Politicians and their populations will need to persevere, especially on structural reforms that improve competitiveness. Countries need competitiveness to sustain growth. They must move away from debt-financing. There is no possibility of sustained growth based on permanent debt accumulation; and by the way, there is no social fairness based on permanent debt accumulation.