Loans due

Despite protests from Spanish banks in particular, the European Central Bank (ECB) is set to drain 442 billion euros ($539 billion) from the market on Thursday by calling in the 12-month emergency loans it issued to some 1,100 financial institutions in June 2009.

The ECB's decision to call in these record-setting sums put banks under pressure and may force some institutions to sell financial instruments at a loss to secure liquidity. Officials, however, sought to reassure the financial world the ECB will do what is necessary to ensure cash supplies remain available.

"The ECB and Eurosystem will do what is necessary to make sure the liquidity is there. There are some banks that are in a less good situation that might eventually suffer, but we will make sure that there are no problems and everything goes OK," ECB Governing Council member Christian Noyer told Europe 1 radio. Noyer is also head of the Bank of France.

Other loans guaranteed

The ECB will continue to provide unlimited three-month loans at 1 percent interest to banks. Those unable to secure less expensive liquidity on the market are likely to take advantage of the offer. Economists say a surge in demand for these shorter loans may indicate the persistence of a credit shortage.

The three-month loans are not subject to the competitive bidding process normally observed under non-crisis circumstances, but collateral is required. A spokesman for the ECB declined to comment about why the 12-month loans were not being renewed when contacted by Deutsche Welle.

It is also expected that European governments will announce the results of "stress tests" performed on more than 100 financial institutions by late July. The results of those tests are another source of financial market uncertainty.

Liquidity problem no longer universal

According to Stefan Schneider, chief international economist at Deutsche Bank, the ECB is keeping with its function by not reissuing 12-month loans. While liquidity problems continue to dog some banks, others have recovered to the point where they can secure capital on the open market, he said.

"The situation is such that individual banks have this problem," he told Deutsche Welle. "The question becomes whether these banks might have a structural problem and should either disappear from the market or be rescued on the national level. In practice, it is no longer a systematic problem."

Schneider also said he doesn't believe surplus liquidity will immediately vanish from the market. Instead he foresees a situation in which banks become stratified by those financially sound enough to secure liquidity on the open market and those with no choice but to rely on the ECB. Financially sound banks will likely shed expensive extra liquidity to help their profitability, he said.

Negative long-term effects

Michael Schubert, a senior economist at Commerzbank, said less liquidity in the market will lead to higher interest rates, making it more expensive for businesses to refinance. But guaranteeing the availability of unlimited ECB loans fosters an atmosphere of dependency and discourages banks from lending amongst one another, he said.

"The Spaniards are probably afraid they won't be able to refinance on the open market, and so the ECB is an alternative," he told Deutsche Welle, explianing that while the ECB is charging 1 percent for loans, cash can currently be obtained on the open market for roughly 0.75 percent.

"The price isn't that much different. What's decisive is the security," he said, adding the global economy is "definitely still in a tense situation."

Author: Gerhard Schneibel
Editor: Sam Edmonds