THE longer term refinancing operation (LTRO) – the European Central Bank’s (ECB) original miracle drug for the liquidity constraints dogging the Eurozone – has reached a crossroads. The banks that first took the pill now want to prove the dosage should be reduced, or stopped altogether.
The hope is that reduced budget deficits, increased competitiveness, and lower leverage in the banking system will eventually leave the Eurozone fit as a fiddle. And as such, banks have been eager to repay cheap funds borrowed from the ECB.
But are they self-diagnosing when they are only partially better? While the 2013 risk on phase has oiled liquidity markets and caused borrowing costs to fall, are peripheral banks able to cope without a safety net if markets freeze over again?
Take Spain. Bond commentators still worry about a return to the rubicon level of 7 per cent yields on ten year government paper if appetite wanes. It’s a risk that is discounted but not removed from the radar.
And last week’s Spanish banking results were telling. Non-performing loans accelerated, and large provisions to cover future losses eroded profitability even for the biggest diversified lenders like BBVA and Santander – with its significant earnings offshore. Christopher Wheeler, a banking analyst for Mediobanca in London, has questioned whether Santander, widely viewed as one of the safest banks in Spain, has enough capital in its Spanish operations. And Santander was among the first to return €24bn (£20.6bn) to the ECB.
Less than a year ago, Santander had €37bn deposited with the ECB, €2bn more than it took from the central bank. At the time, its chairman described this as akin to insurance. But he now believes we are witnessing a new phase. Why then are Spanish non-performing loans rising to 6.74 per cent and provisions steeper than ever at €18.8bn?
Friday’s latest LTRO repayment update caused an initial sell off in risk. Only 27 banks, compared with 278 a week earlier, said they intend to hand back funds. They also said they’d return a measly €3.48bn of three-year LTRO money, when €20bn was the expectation. Perhaps the lower repayments should have triggered applause, as more banks chose to keep the funds on balance sheets.
What this highlights is a more normal investor psyche. Remember the days when the need for stimulus was viewed as a sign of weakness? Too often since the crisis, we’ve seen markets rush on injections by the ECB, the Fed and the Bank of Japan. Maybe it’s an early indication that investors will take the exit from extraordinary measures in their stride.
Karen Tso is an anchor for Squawk Box Europe on CNBC.