One of the goals of ECB president Mario Draghi’s LTRO plan was to get banks to deleverage. Instead it concentrated the risks.

For a case in point, please consider Europe Banks Fail to Cut as Draghi Loans Defer Deleverage.

Lenders in the euro area increased assets by 7 percent to 34.4 trillion euros ($45 trillion) in the year ended July 31, according to data compiled by the European Central Bank. BNP Paribas SA (BNP), Banco Santander (SAN) SA, and UniCredit (UCG) SpA, the biggest banks in France, Spain and Italy, all expanded their balance sheets in the 12 months through the end of June.

They have Mario Draghi to thank. The ECB president’s decision nine months ago to provide more than 1 trillion euros of three-year loans to banks eased the pressure to sell assets at depressed prices. The infusion, designed to encourage firms to lend, succeeded in averting a short-term credit crunch by reducing their reliance on markets for funding. It also may be making European lenders dependent on more central-bank aid.

“Deleveraging isn’t taking place, especially in Spain and Italy,” said Simon Maughan, a bank analyst at Olivetree Securities Ltd. in London. “The fact that we haven’t got on with it, or very slowly, suggests that when the time comes we’ll need another ECB injection to roll over the first one, just to keep the balance sheets of Italian banks in business.”


The ECB’s longer-term refinancing operation, or LTRO, changed the timetable. The Frankfurt-based central bank extended 489 billion euros of three-year loans to European banks in December in the first phase of the program. Two months later, it loaned 530 billion euros to 800 firms.

Deleverage? What Deleverage?

“Thanks to Draghi, the massive shrinkage that was looming six months ago across Europe isn’t happening — at least not yet,” said Nikolaos Panigirtzoglou, an analyst at JPMorgan Chase & Co. in London. “That’s what the economy needed on the short term.”

Actually, it’s not what the economy “needed” at all. It’s what the financial markets needed.

The European markets rallied since LTRO because German and French banks were able to unload Spanish sovereign debt garbage onto Spanish banks.

Unfortunately, the economy certainly did not need more concentration of risk in banks that have failed or are about to fail. Nor did Spain specifically.

Government Debt Held by Spanish Banks Doubles in Seven Months

Via Google translate from El Economista, please consider Government Debt Held by Spanish Banks Doubles in Seven Months

Spanish debt changes hands. The extraordinary monetary policy of the European Central Bank (ECB) and the distrust generated by the crisis are the main catalysts of the drastic change that are having this market in 2012.

In his slipstream, two opposing trends. On the one hand, the increasing role of national banks that hoard and almost one in three volume euros in circulation, almost double that in late 2011, and secondly, the withdrawal of foreign investors, who have reduced their exposure to Spanish debt significantly pending clarification that the outlook for public finances.

As central banks attempt to counteract forces of deleveraging (deflation) systemic risk of the largest lenders grows by leaps and bounds. The “success” of the LTRO was nothing more than offloading risky assets back into countries such as Spain that cannot afford more losses (yet are on the verge of getting them).

Mike “Mish” Shedlock
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