ECB may extend loan terms

Central bank attempts to limit the damage to the interbank market

BRUSSELS - The European Central Bank (ECB) is looking at extending the term of loans it offers banks to two or even three years to try to prevent the eurozone crisis precipitating a credit crunch that chokes the bloc's economy, according to people familiar with the matter.

The ECB is examining this unprecedented possibility as intensifying fears about the eurozone succumbing to its debt crisis hurt the interbank money market, with lenders scaling down the list of peers to which they are ready to lend.

The ECB is looking into offering banks liquidity over a two- or even three-year period, the sources said, in an attempt to free up the increasingly blocked interbank money market and provide lenders with more leeway to buy and hold sovereign bonds.

To date, the longest term it has offered funds is one year.

As the sovereign debt crisis worsens, the ECB has been coming under increasing pressure to intervene on a larger scale by buying state bonds but is reluctant to make such a commitment.

It does, however, have the freedom to lend banks trillions of euros and could use this firepower to indirectly support governments trying to issue debt.

The ECB has flagged the possibility of longer-term loans to banks in a move that could be aimed at gauging their interest ahead of a launch, sources familiar with the matter told Reuters.

The possibility of lending over a longer time period was raised at a meeting last week between the ECB and a group of banks including Goldman Sachs Group Inc, Barclays Capital, the investment banking division of Barclays PLC, and Morgan Stanley, according to a person familiar with the matter.

"What was said was that they would be prepared to offer two or three years LTRO (Longer-Term Refinancing Operation)," the person said.

"The question (for the ECB) is whether banks would be interested in it. It could be seen as a stigma if a bank was using two- or three-year financing with the ECB. It might not get enough take-up to make a difference."

Another source said the ECB was looking at the possibility of providing liquidity over a similar period, but by making a series of shorter-term loans with a pledge to keep this line of credit open for up to three years.

A third official familiar with the matter said: "It's being discussed ... but there is no decision yet."

The ECB first introduced extra-long 12-month liquidity tenders in June 2009. Last month, it renewed offers to lend banks one-year funding in two operations this year - a 12-month LTRO in October and a 13-month operation in December. In these operations, banks receive all the funds they ask for.

However, there has only been lukewarm interest, suggesting that more ECB cash may not be the answer to a creeping credit freeze.

Interbank markets remain tight, with lenders worried about the health of their peers and also holding back cash as they face the prospect of having to set aside funds to cover potential losses on their sovereign-debt holdings. International demands that they raise their capital base have exacerbated the problem.

This nervousness was highlighted on Tuesday when eurozone banks' demand for ECB funding surged to a two-year high, as fast-spreading sovereign-debt concerns left lending markets virtually frozen and the ECB as the only source of funding for many institutions. Earlier this week, an ECB Governing Council member, Luc Coene, said regulators must ensure banks take account of the riskiness of the government bonds they own, adding to pressure on banks to set aside more capital to cover such losses.

By offering banks liquidity for an ultra-long period of two or three years, the ECB could help reinforce confidence in the banks and also do the same for the rocky sovereign-debt markets.

"To the extent that you are improving the situation for banks, you are improving the situation for a major potential purchaser for sovereign debt," said one banker. "They will know that they can refinance with the bank (ECB)."

One senior executive from a European bank, speaking anonymously, said he favored an extension of the terms under which the ECB lends to banks.

"Now, it's 13 months and if we could go to 24 months, that would be better. Thirty-six months would be better still but then we are at the point of medium-term financing."

Reuters