Slow credit flow worries Europe

‘Wall of money’ has limits, central bank official warns

Jens Weidmann, president of Germany’s Bundesbank, speaks Wednesday at a forum at Chatham House in London.
Jens Weidmann, president of Germany’s Bundesbank, speaks Wednesday at a forum at Chatham House in London.

— The European Central Bank says the flow of credit to businesses slowed in February — a sign that the bank’s enormous loans to the financial system have yet to spur a fragile eurozone economy.

The downbeat numbers were released as a key member of the bank’s governing council warned again about the risks involved in the $1.33 trillion two-stage action that flooded the banking industry with cheap three-year loans.

Jens Weidmann, head of Germany’s Bundesbank, said the European Central Bank’s “wall of money” was needed as an emergency measure — but has only bought Europe time to fix its problems.

Figures released Wednesday showed loans to nonfinancial corporations, a key credit indicator, fell by $4 billion in February compared with the month before, after increasing by only $1.3 billion in January.

Compared with the same month a year ago, loans to businesses grew by only 0.4 percent, down from 0.7 percent in January.

The central bank made two rounds of cheap loans — known as the “longer-term refinancing operation” — to banks on Dec. 21 and Feb. 29, adding about $666 billion in net new credit to the financial system. The loans were introduced in the hope that the money would find its way to businesses and consumers as loans and, in turn, promote growth.

The central bank lent just more than $1.3 trillion, hand- ing out $651 billion to 523 banks on Dec. 21 and another $705 billion to 800 banks on Feb. 29 at a current interest rate of 1 percent. The total new credit comes out to about $666 billion because banks moved some of their earlier borrowing from other central bank loan offerings to the two socalled longer-term refinancing operations.

The loans are credited with easing the eurozone debt crisis by removing fears that one or more of Europe’s shaky banks might fail, and by making it easier for heavily indebted governments such as Italy to borrow on bond markets. High borrowing costs have already pushed Greece, Ireland and Portugal to take bailout loans from other euro countries.

But the 17-country currency bloc is still going through what is expected to be a mild recession that will complicate efforts to reduce the debt loads plaguing governments. European Central Bank President Mario Draghi said the aim of the loans was to avoid a credit crunch that would choke off the finance that businesses need to expand and hire people.

Central bank Vice President Vitor Constancio said the bank did not simply assume that its loans would immediately begin flowing through as credit. The central bank’s goal was to enable banks to tap bond markets themselves as they do in less stressed times, he said.

Those bank funding markets had frozen late last year because of fear of bank failures but have since started to reopen, with banks in indebted countries issuing unsecured bonds again.

“It never crossed our minds ... that we were solving the sovereign debt crisis with this,” Constancio said after giving a speech at Frankfurt’s Goethe University. “It was not even about trying to see if suddenly credit could increase a lot in such a depressed situation as we are, because it won’t happen.”

Banks don’t lend based on their reserves at the central bank, but by assessing risk and profit — and know they can’t build up their business relying on temporary credit from the central bank, he said. Instead, they will prefer to go back to their normal funding markets.

Credit also remains tight because banks are under pressure from the European Union to increase their financial buffers against future turbulence from the debt crisis. Money held back to strengthen bank finances would not be available for loans.

Additionally, the second loan offering came only on the last day of February, too late to help that month.

Draghi downplayed some of the risks of the central bank’s bold move in a speech Monday, saying they warded off a serious collapse and that the risks are being managed. He said lending is too slack now to pose much danger of inflation and that the central bank is well insured against losses on the collateral it accepted for the loans.

Weidmann, who represents Germany’s traditionally conservative stance on monetary policy, has been more emphatic about the risks.

He has only one vote on the central bank’s 23-member governing council, but his job as top central banker in the eurozone’s biggest country gives him a prominent platform.

He said the “wall of money” deployed by the European Central Bank was sensible to contain the crisis but added that “just like the ‘Tower of Babel’ the ‘Wall of Money’ will never reach heaven.”

“If we continue to make it higher and higher, we will, in fact, run into more worldly constraints — both financial and political ones,” he said.

The loans have made it easier for indebted governments to borrow, as some of the banks have used the loan money to buy government bonds. Weidmann said the crisis had temporarily blurred the boundary between central bank activities and government finances but warned that getting involved in supporting governments would be disastrous for a central bank.

“Once a central bank becomes involved in fiscal policy, it eventually loses its independence and its credibility as an inflation-fighter. This is the story told not only by economic theory but also by historical experience,” he said.

The central bank is legally independent and forbidden by the European Union treaty from lending money directly to governments. The reason is to prevent governments from pressuring it to use its power to print money to solve their financial problems.

Draghi has stressed that helping governments borrow was not the reason for the loans.

Business, Pages 21 on 03/29/2012

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