As primary FIG supply has faded following the binge of the first half of January, talk has once again turned to the ECB's second long-term refinancing operation (LTRO). While some predict that more than €1tr will be allocated and argue that the effect will be positive no matter how large the amount, others counter that too much take-up will have negative consequences.
Moody’s this week published research that suggested the LTRO was credit negative for European banks, because it increased reliance on central bank funding, raising the risk of funding concentration and exposing banks to political decisions they cannot control. The agency also pointed out that by replacing unsecured debt with collateralised central bank funding, banks weaken their funding flexibility.
Bankers poured scorn on the report. They might be overstepping the mark, but it's easy to see why the agency's view has raised hackles.
The effects of the LTRO are clearly not credit negative in the short term. The two year FRN market has been awash with deals as investors, led by bank treasuries reinvesting their own ECB funds, plough into bonds which, by extension, carry an ECB guarantee. But it's not just the short end: the senior market has been revived across the maturity spectrum.
Moreover, Moody’s report did not tell us anything we didn’t know. Mario Draghi has not single-handedly saved the European banking system from crisis — despite his claim to have staved off a “major, major credit crunch”. But the measure has bought banks time to recapitalise and focus on their structural problems without having to worry about when and where they are going to get their next funding fix. It is clearly not intended to be a long-term solution, and banks are certainly not being encouraged to see it as one.
But Moody’s is right, of course, to warn against relying too heavily on state funding. It would be an easy trap to fall into. It didn’t take long after the first LTRO for the frenzy to calm down and for the market to start speculating about the next operation.
And look what happened with government guarantees: intended to be a temporary measure, they were reintroduced at the end of last year. Not only that, but they created a wall of redemptions in 2012, which is part of the reason the LTRO was introduced in the first place.
The next LTRO is supposed to be the last, but if the rally fizzles out and the market demands another fillip, might Super Mario be inclined to announce another? Perhaps, but it would be folly to build your business model on that assumption.
Relying on ECB funding is not sustainable, then, but building a sustainable banking system will take time. The LTRO provides that. The thought of where the sector would be without it ought to concentrate minds and ensure that the time is used wisely.