ECB to Lend Greater-Than-Forecast $645 Billion as Banks Line Up for Funds

The European Central Bank will lendeuro-area banks a record amount for three years in its latestattempt to keep credit flowing to the economy during thesovereign debt crisis.

The Frankfurt-based ECB awarded 489 billion euros ($645billion) in 1,134-day loans today, the most ever in a singleoperation and more than economists�� median estimate of 293billion euros in a Bloomberg News survey. The ECB said 523 banksasked for the funds, which will be lent at the average of itsbenchmark interest rate -- currently 1 percent -- over theperiod of the loans. They start tomorrow.

��It was obviously an offer the banks could not refuse,��said Laurent Fransolet, head of fixed-income strategy atBarclays Capital in London. ��It shows the ECB is not out ofammunition and it gives banks security on liquidity for a fewyears. On the other hand it means banks will rely on the ECB forlonger.��

Europe��s debt crisis has increased the risk of governmentand bank defaults, making institutions wary of lending to eachother and driving up the cost of credit. The ECB is trying toensure that banks have access to cheap cash for the medium termso that they can keep lending to companies and households. Inaddition to the longer-term loans, the ECB has widened the poolof collateral banks can use to secure the funds.

New Money

Barclays estimates today��s operation will inject 193billion euros of new money into the system, with 296 billioneuros accounted for by maturing loans. The ECB also lent banks$33 billion for 14 days in a regular dollar offering, up from$5.1 billion a week ago, and 29.7 billion euros for 98 days.

The euro jumped half a cent to $1.3198 before retreating to$1.3092 at 1:25 p.m. in Frankfurt.

��More important than the size of the operation is whatbanks do with this cash,�� said Simon Smith, chief economist atforeign-exchange broker FXPro Group Ltd. in London. ��Thedichotomy between size and use explains why the euro struggledto maintain its initial positive reaction to the! news.��

Spanish two-year notes extended a decline, snapping aneight-day gain and sending yields 14 basis points higher to 3.49percent. Italian notes also dropped, pushing the yield 29 basispoints higher to 5.27 percent.

��Through the Backdoor��

Yields on government bonds in Italy and Spain fell in thedays after the ECB announced the loans on Dec. 8 as banks boughtthe securities to use them as collateral in today��s tender.French President Nicolas Sarkozy has suggested banks could usethe loans to buy even more government debt.

Simon Derrick, chief currency strategist at Bank of NewYork Mellon Corp, said the loans amount to quantitative easing��through the backdoor.��

��What the ECB is doing is providing ultra-cheap money tobanks, which in turn are going to be in there buying thesovereign debt up,�� Derrick told Linzie Janis on BloombergTelevision��s ��First Look�� earlier today. ��That��s good news inthe sense that it��s clearly going to help sovereigns in the nearfuture, but it��s also printing more money. That��s going to startto weigh on the euro over time.��

Martin van Vliet, an economist at ING Group in Amsterdam,said banks are more likely to use the loans to ��finance creditto the private sector or to repay maturing bank debt.��

��We doubt whether the money will be used extensively tofund purchases of peripheral debt,�� he said.

Refinancing Needs

ECB Vice President Vitor Constancio in a Dec. 19 interviewpredicted ��significant�� demand for the loans as banks face��very high refinancing needs early next year.��

Some 230 billion euros of bank bonds mature in the firstquarter of 2012 alone, ECB President Mario Draghi told theEuropean Parliament this week.

��Banks represent about 80 percent of lending to the euroarea,�� Draghi said. ��The banking channel is crucial to thesupply of credit.�� He predicted banks will experience ��verysignificant funding constraints�� for the ��whole�� of 2012.

Banks from the 17-nation euro reg! ion need to refinance 35percent more debt next year than they did this year, accordingto a Bank of England study. Lenders have more than 600 billioneuros of debt maturing in 2012, around three quarters of whichis unsecured, the study says.

Focus on Banks

The ECB is focusing on greasing the banking system to fightthe debt crisis as it resists calls to increase its bondpurchases to reduce governments�� borrowing costs. Today��slending exceeded the 442 billion euros awarded in the ECB��sinaugural 12-month loan in 2009.

The ECB said 123 banks shifted a total of 45.7 billioneuros into the three-year loan from an existing one-yearfacility allotted in October. The central bank will offer asecond three-year loan on Feb. 28 and borrowers have the optionof repaying the funds after a year.

��It��s very significant and very helpful for the banks,��Jacques Cailloux, chief European economist at Royal Bank ofScotland Group Plc in London, told Bloomberg Television. ��Butit��s not going to bring about a turning point in this crisis.��

As long as Europe��s leaders fail to agree on the rightpolicy mix, which should include sovereign-debt restructuring ora move to common bonds, the ECB��s measures won��t end theturmoil, Cailloux said.