ECB CONSIDERS ACTION ON " ADDICTED" BANKS / THE FINANCIAL TIMES ( RECOMMENDED READING )

ECB considers action on ‘addicted’ banks

By Ralph Atkins in Frankfurt

Published: September 19 2010 17:51

High levels of dependency by some banks on the European Central Bank’s unlimited offers of liquidity has prompted an internal debate among its policymakers on possible further action against Europe’s “addicted” financial groups.

Despite improved confidence generally in financial markets in recent months, a significant number of eurozone banks still appear unable to find alternative sources of funds, especially in countries such as Portugal, Ireland and Greece. “There is an obvious problem of so-called addicted banks,” Ewald Nowotny, Austria’s central bank governor, said on Friday.

Until now, the ECB has urged national governments to take action to strengthen or close down stricken banks and to restore investor confidence by bringing spiralling public debts back under control. But its governing council members are also considering what action the Frankfurt-based institution might take to speed up a “detox” process.

The risk is that, without action, a few weak banks could delay the ECB’s exit from exceptional measures taken after the collapse two years ago of Lehman Brothers, since which time it has been matching in full banks’ bids for liquidity.

Overall lending by the ECB has fallen to about €600bn ($780bn) compared with peaks of up to €900bn. But the amounts have stabilised at high levels in those countries worst hit by this year’s crisis over public finances. Greek, Spain, Portugal and Ireland account for 61 per cent of the total, despite comprising only 18 per cent of eurozone gross domestic product.

Details are scant on which banks are drawing the most liquidity, and much of it may not be essential. But Jacques Cailloux, European economist at the Royal Bank of Scotland, said: “The ECB will know whether banks are using its liquidity for arbitrage – or survival; it has information that is not available publicly. My hunch is that they have concluded some banks are dependent on central bank liquidity. So they have to do something about that before they can ‘exit’ from non-standard measures.”

The ECB is under no pressure to act soon – and any steps could face legal problems. The ECB has extended until at least early 2011 the provision of unlimited weekly, monthly and quarterly funds. But it will need to have addressed the problem of addicted banks if it intends, later in 2011, to press ahead with an exit strategy that would see a return to the pre-crisis system of auctioning liquidity.

One option would be to impose limits on auction bids by individual banks, perhaps according to their size. Additional funds would then have to be obtained via a different ECB facility. That would prevent the auction process from becoming distorted by banks that have to have liquidity at any price.

An alternative would be to adjust rules on the collateral banks must provide when obtaining liquidity from the ECB to prevent the use of assets most likely to be put up by addicted banks.

One objection to any targeted action would be that it would stigmatise problem banks – something the Frankfurt-based institution has sought to avoid over the past three years.

Copyright The Financial Times Limited 2010.