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Financial Instability Continues in the EU as ECB Lending Spikes

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Many traders say that if this level of lending continues, the interbank lending system may collapse. (Image: Svilen Milev)
Many traders say that if this level of lending continues, the interbank lending system may collapse. (Image: Svilen Milev)

FINANCE

  • ECB lending at 2%, much higher than the 0.74% paid for marketplace funding
  • Germany proposes more ECB bond buys, sanctions for overspending
  • IMF to protect EU funds, provide $270 billion to EU

The European Central Bank is lending money to banks at the highest rate since March, signaling tight funding at the market level. Lending has spiked to $11.59 billion, worrying traders who have not experienced such an increase since Irish banks needed central bank funding.

The price to borrow from the ECB is 2%, a figure much higher than the 0.74% paid for marketplace funding. When limited credit availability forces banks to use central banks, their costs add pressure on already vulnerable banks. One trader explained to the Financial Times that for every 40 large banks seeking funding, there is only one large corporate bank willing to lend.

Many traders who spoke with the Financial Times say that if this level of lending continues, the interbank lending system may collapse.

Global Move to Create Liquidity

International concern for Europe's economic instability has triggered action from various  central banks around the world who wish to create liquidity. China is reducing its bank requirements to 20% for the first time in three years, while Brazil is cutting its benchmark Selic rate by 50 basis points for the third time in four months.

Due to increased affordability in dollar swap lines, the Federal Reserve is now allowing the ECB to offer cheaper dollar loans to its banks. In hopes of increasing liquidity, the ECB now offers three-months of dollar liquidity to increase the appeal of existing swap lines.

The ECB may soon request less collateral for its dollar loans, cutting the margin on assets to 12%. According to Tony Crescenzi, a strategist at Pimco, liquidity provisions are only temporary and are not substitutes for necessary actions Europe must take to solve its credit problem.

Europe Weighs Its Options

Strategists at the Financial Times think European lawmakers are beginning to realize the depth of the crisis. ECB President Mario Draghi told the European parliament that “the most important thing for the ECB is to repair the credit channel.”

Draghi suggested that next ECB meeting might provide more solutions, with possible discussions centered on offering loans to banks for as long as three years and broadening the types of collateral banks can use to gain liquidity.

France and Germany are currently pushing for more ECB bond purchases, and German Chancellor Angela Merkel has urged for sanctions on countries who overspend. Such measures may be included in changes to EU treaties.

Credit Agricole's analysts believe a fiscal spending limit will allow the ECB to increase bond purchases. Although Draghi has suggested that bond purchases may occur, the purchases “can only be limited.” Another proposal is a limitation on government bond yields.

European bonds realized big gains in the week ending in December 2,when many Eurozone yields fell. Italian yields dropped 25% of a point on 10-year bills, while German yields for its one-year bonds turned negative as investors seek refuge from the market liquidity crisis.

Under a new proposed plan with the International Monetary Fund, EU borrowing funds could soon be channeled through a trust fund or be used toward the IMF's general resources. Central banks will use the IMF to recycle funds to underwrite lending programs in Italy and Spain.

An expected $270 billion will be received to help tackle the debt crisis. So far, four rescue plans over the last 19 months have led to little reprieve. Analysts believe the Euro may collapse unless Europe's economy becomes more united.

Using the IMF as a resource will unlock credit without violating EU direct financing rules, but the IMF plan would not replace EU bond purchases.

Key Statistics – European Economy (source: Eurostat)

  • When compared with the previous year, September's new industrial orders jumped 2.3% for the European Union and 1.6% for the Eurozone.
  • In comparison with other European nations, Germany is the EU's top exporter with 27% of total EU exports. The UK and France hold second with 9% of total exports.
  • Economists are predicting that November's annual inflation rate for Europe will remain at 3%.

By Nicole Manuel for
Nicole Manuel is a freelance economics, finance and blog writer with a degree in economics and over two years of experience.

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