ECB FOCUS-South’s cash addiction to force continuing ECB drip

* Southern European banks increasingly reliant on ECB funds

* Problems to lead ECB keeping unlimited lending in place

* Bank stress tests provided only short-term help

* Two-speed recovery complicates ECB’s task

By Sakari Suoninen

FRANKFURT, Aug 20 (BestGrowthStock) – The European Central Bank will
have little option but to keep flooding the money market with
cash to aid banks and governments in the common currency area’s
troubled southern periphery, despite robust growth in the core.

Southern Europe has been hit hard on several fronts
recently. First the sovereign debt crisis hit Greece and other
southern periphery countries, then bank stress tests showed 6
out of 7 failing banks were in Spain or Greece, and then the
region posted only tepid growth while most of the euro zone was
humming along nicely, all weakening confidence in banks.

Bank borrowing from the ECB shows increasing strains in
southern euro-zone’s financial sector while banks elsewhere are
getting back on their feet, but the fear of contagion from
country to country will keep the ECB on its toes.

Total use of ECB funds has dipped in recent months, but
southern periphery banks rely on the ECB in the face of
continued reluctance among peers to lend.

Analysts said this would reinforce the argument for the ECB
to extend its unlimited cash offers into next year — an outcome
looking increasingly likely after Germany’s Axel Weber joined
other policymakers in backing an extension on Friday.

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For a graphic on bank borrowing from the ECB by country,
click on: http://r.reuters.com/ryj95n

For a graphic of overall ECB lending, click on (ECBOMO=ECBF: )
and then right click and choose related graph

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Banks in Greece borrowed twice as much last month as they
did in July 2009, even though outstanding central bank lending
fell 18 percent over the same time. Banks in Portugal borrowed
five times as much in July 2010 as they did a year earlier, and
borrowing also rose in Spain and Italy.

“The full-allotment fixed-rate repos will stay well into
next year,” said Michala Marcussen, Societe General chief
economist.

“Beyond the first quarter of next year, the overall economic
environment will be the key determinant in how much longer it
gets carried. In all likelihood it could get carried further
ahead.”

STRESSED

The ECB introduced unlimited fixed-rate loans in October
2008 and has promised to keep them in place in the shorter-term,
one week and one month operations until at least mid-October,
and until the end of September for three-month money.
Fourth-quarter plans are due to be revealed in September.

The ECB tried to reintroduce limits to borrowing in April
but was forced into a U-turn by the sovereign debt crisis,
returning to its full allotment policy in May.

Cyprus’s Athanasios Orphanides and Ireland’s Patrick Honohan
have indicated the unlimited funding should continue. But Weber
made clear exit discussions should not resume until early next
year and his dovish tone got analysts’ attention.
[ID:nLDE67J0IR]

“The key message is that the ECB is willing to stay there as
long as it has to and that it believes that it needs to be
present and keep those full allotments,” Marcussen said.

There were great hopes that last month’s bank stress tests,
the latest salvo in the battle to improve confidence, would calm
the market but their impact is already waning after muted
positive signals at first.

“There has to be increased confidence of health or the
perceived health of the banking system (for phasing out crisis
measures),” said RBS economist Nick Matthews.

“The stress tests were an opportunity to do that, but it
does seem as though some of the positive results seem to be
wearing off, so maybe these stress tests were a missed
opportunity.”

Only seven of the 91 banks tested failed, and some analysts
thought the scenarios were too lenient. [ID:nSGE66M07W]

PREVENTING SPILLOVER

The euro zone is seeing an increasing split not only in
banking, but in the economy as a whole, further complicating the
ECB’s task. While the euro-zone economy boomed in the second
quarter with Germany setting the tone, southern Europe recorded
much more muted growth. [ID:nLDE67C0YX]

The ECB stresses consistently its policy takes into account
the whole of the euro zone, not individual countries.

“I think it is a challenge that we had to face permanently
since the very beginning of the euro,” Trichet said earlier this
month, brushing off concerns that uneven economic development
was an especially pressing problem right now.

But neglecting banks’ difficulties even in relatively small
countries would exacerbate the economic split and threaten to
get the south mired in a credit crunch.

Moreover, the Greek debt crisis showed that developments in
one small country can have dramatic implications for others, and
banks are dependent on each other across borders.

“Because of the interlinkages between the European banking
systems, if there are issues in one country, these will domino
into other countries,” SocGen’s Marcussen said.

“It is not just about supporting the peripheral countries,
it it about offering support to the European banking sector.”

The ECB’s promise of continued unlimited funding would
reduce uncertainties and give banks and governments time to
bridge their credibility gap.

Liquidity injections have an important role not only in
helping banks, but also in easing government financing woes, as
sovereign bonds can be used as collateral against ECB loans,
making them more attractive to banks, analysts said.

“The ECB is not just financing the banks that obtain funds
more cheaply, it is also financing the governments (through the
tenders)”, said Filipe Garcia, an economist at the Informacao de
Mercados Financeiros in Porto, Portugal.

The central bank would not be doing its job as guardian of
the economy were it to ignore problems in the south, he added.

“If the ECB was not present, it would not be assuming its
role as a central bank,” Garcia said.
(Additional reporting by Axel Bugge in Lisbon and Krista Hughes
in Frankfurt; editing by Patrick Graham)

ECB FOCUS-South’s cash addiction to force continuing ECB drip