ECB hands out cheap credit to banks to boost economy

BY EVA TAYLOR AND JOHN O'DONNELL

FRANKFURT Thu Sep 18, 2014 5:35am EDT

(Reuters) - The European Central Bank handed out the first of its new four-year loans to banks on Thursday, the flagship tool in a new stimulus package it hopes will stave off price deflation and revive the ailing euro zone economy.

Take-up of the 400 billion euro offer of cheap credit from the euro zone's central bank was low but banks will get a second chance in December to apply for the cash, which is granted on condition that they lend to businesses.

The launch of the scheme, a central plank of the ECB's efforts to coax reluctant banks to lend more and fire up the bloc's flagging economy, saw the ECB handing out 82.6 billion euros of such credit to 255 banks.

The success of the project is important for the 18 countries in the euro zone, grappling with record-high unemployment and fading economic growth.

But previous rounds of ultra-cheap ECB loans and borrowing costs close to zero have done little to boost lending to companies, with much of the money instead spent on government debt. Critics fear a similar fate for the new scheme.

Many banks were reluctant to participate in Thursday's round, possibly for fear that it could single them out as struggling just weeks before the results of ECB-led health checks on the sector are announced.

"The European financial sector continues to be weak," said Karel Lannoo of Brussels think tank the Centre for European Policy Studies. "There may be a stigma because the markets are waiting for the AQR (Asset Quality Review) in a few weeks."

Thursday's poor take-up was worse than predicted by a Reuters poll of 20 money market traders, who said banks would take just 133 billion euros this week but return to snap up a further 200 billion euros on December 11.

The euro gave up gains after the news.

"This may disappoint the market," said Johannes Mayr, an economist with BayernLB.

"It also raises expectations for the purchase programme of securitized debt and it could fuel speculation that the ECB may have to buy other assets on top, such as government bonds."

Banks are able to borrow up to 400 billion euros at tenders this week and in December, at a slight premium to the ECB's regular price of funding. If they start lending more, they can take further cheap ECB loans running through to mid-2016.

"We would warn about drawing too strong conclusions from the September round," said ABN Amro analyst Nick Kounis, who expects a total take up of 350 billion euros this year.

Another reason for banks holding fire is to find out more about a separate ECB program to buy asset-backed securities and covered bonds. Details are expected in October.

They may also choose to hold on to existing crisis loans from an earlier ECB programme for longer.

The ECB flooded the market with cheap three-year loans at the height of the debt crisis in late 2011 and early 2012. They expire early next year and many banks are expected to use the new four-year loans to pay back such debt.

Lannoo said he was sceptical that the new initiative would lead to more lending to the smaller businesses that are the euro zone's economic backbone as previous long-term loans to banks had failed to do so.

"Has this helped to improve credit to the private sector? Not much," he said. "It has not reduced the divide between north and south."

Figures on Friday showing how much of those crisis loans banks will repay next week and the result of next week's main refinancing operation may give an indication of how much will be rolled over into the new operations.

Nomura, which forecasts total take-up this year of between 250 billion and 300 billion euros, said that Italian and Spanish banks would make full use of their four-year loan allowances, which it puts at 75 billion and 54 billion euros, respectively.

(Additional reporting by John O'Donnell; Editing by Catherine Evans)