The headquarters of the European Central Bank (ECB) in Brussels. The ECB said 523 banks asked for funding, which will be lent at the average of its benchmark rate - currently 1 percent - over the period of the loans. [Hannelore Foerster / Bloomberg]

Institution moves to ensure that banks have access to cheap cash

LONDON / BERLIN - The European Central Bank (ECB) announced on Wednesday that it will lend eurozone banks 489 billion euros ($645 billion) in 1,134-day loans in its latest attempt to keep credit flowing to the economy during the sovereign debt crisis.

The amount was more than economists' median estimate of 293 billion euros in a Bloomberg News survey.

The ECB said 523 banks asked for the funds, which will be lent at the average of its benchmark rate - currently 1 percent - over the period of the loans. The ECB also lent banks $33 billion for 14 days in a regular dollar offering, up from $5.1 billion a week ago.

Government bond markets may continue to rally if demand for the three-year loans exceeds 250 billion euros, Steven Barrow, head of G10 currency strategy at Standard Bank PLC in London, said before the ECB announced the results.

Europe's debt crisis has increased the risk of government and bank defaults, making institutions wary of lending to each other and driving up the cost of credit.

The ECB is trying to ensure that banks have access to cheap cash for the medium term so that they can keep lending to companies and households.

In addition to the longer-term loans, the ECB has widened the pool of collateral banks can use to secure the funds.

Italian and Spanish government bond yields have dropped since the ECB announced the loans on Dec 8 as banks buy the securities to use them as collateral.

French President Nicolas Sarkozy has suggested banks could use the loans to buy even more government debt.

'Carry trades'

"What the ECB wants is that the funds be used by banks to keep handing out loans," said Michael Schubert, an economist at Commerzbank AG in Frankfurt.

"But there's a second argument, which is to do carry trades by borrowing on the cheap at the ECB and buying sovereign bonds. We don't know what the banks are using the money for," Schubert said.

ECB Vice-President Vitor Constancio in an interview on Monday predicted "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 first quarter of 2012 alone, ECB President Mario Draghi told the European Parliament this week.

"Banks represent about 80 percent of lending to the euro area," Draghi said. "The banking channel is crucial to the supply of credit." He predicted banks will experience "very significant funding constraints" for the "whole" of 2012.

No turning point

Banks from the eurozone need to refinance 35 percent more debt next year than they did this year, according to a study by the Bank of England. Lenders have more than 600 billion euros of debt maturing in 2012, around three-quarters of which is unsecured, the study said.

The ECB is focusing on greasing the banking system to fight the debt crisis as it resists calls to increase its bond purchases to reduce governments' borrowing costs. It will offer a second three-year loan in February.

"It's very significant and very helpful for the banks," said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group PLC in London. "But it's not going to bring about a turning point in this crisis."

Bloomberg News