The LTRO may have ignited the bond markets and the stock market but it did not do anything for bank lending. The New York Times reports Survey of European Banks Shows a Sharp Cut in Lending

Banks in the euro area cut lending sharply at the end of 2011, according to data published Wednesday, raising concern that Europe was on the verge of a credit crisis that could lead to a deeper recession than expected.

A quarterly survey of commercial banks by the European Central Bank showed a surge in the number of institutions that were becoming more restrictive about who they lent to, because the banks themselves were having trouble raising money and were under pressure from regulators to reduce risk.

“It is obvious that we see a deleveraging, a retrenching process unfolding,” Thomas Mirow, the president of the European Bank for Reconstruction and Development, said in an interview last week. He said the figures from the Bank for International Settlements showed “this is not just perception but reality.” The reconstruction bank provides credit to support the development of free markets in the former Soviet bloc.

Banks tightened their lending standards for businesses as well as for individuals, according to the central bank. Of the banks surveyed, 35 percent said they were applying stricter criteria to business loans compared with 16 percent in the previous quarter. Banks also became more reluctant to provide mortgage loans. And they said they expected credit to become more scarce in months to come.

Germany was an exception. Lending there remained steady, according to separate data published Wednesday by the Bundesbank, the German central bank.

One reason banks in the euro area are reluctant to lend is that they have their own problems raising money. About half said they were still having trouble getting access to money markets, the central bank said. Funds in the United States and elsewhere that lend large sums to banks remain wary of the health of many euro area institutions because of their holdings of European government bonds.

A fifth of banks surveyed said that the need to raise their capital reserves had forced them to restrict lending. But twice that many banks said the flagging euro area economy was the main reason for tighter credit standards.

Three Reasons LTRO Will Not Get Banks to Lend

Contrary to popular belief the LTRO is not going to do much if anything to get banks to lend. Here are the reasons.

  1. Banks are capital impaired if not outright insolvent
  2. There are few credit-worthy borrowers
  3. Banks have three years guaranteed profits by speculating in government bonds

There is much ongoing debate about whether or not LTRO funding will be used to speculate in government bonds and if so how much. The bulk for the money so far as been to rollover debt, but the temptation to borrow from the ECB at 1% and buy 3-year Spanish bonds yielding 2.89%, 3-year Irish bonds yielding 5.43%, or 3-year Italian bonds at 3.8% is extremely high.

Note that even 2-year bonds are in play. For example, 2-year Italian bonds yield 3.17%. Thus, the idea that none of the LTRO will go into government bonds is unlikely to hold up under scrutiny.

Indeed banks are salivating to double or triple the €489bn they borrowed in December. For details please see You Ain’t Seen Nothin’ Yet; Another Trillion (or Two) Euro LTRO Coming Next Month

The LTRO is good for bank profits, for now, but please remember that speculation in government bonds is what got European banks into trouble in the first place.

Mike “Mish” Shedlock
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