Banks rush to borrow €489bn from ECB

European Central Bank sees massive demand for its three-year loans at low interest rates

Banks gorged on €489bn (£407bn) of liquidity support from the European Central Bank yesterday as the eurozone's lender of last resort sought to avert a new continent-wide credit crunch. More than 500 private lenders rushed to swap eurozone sovereign bonds and other assets at the ECB for three-year loans offered at low interest rates.

European banks have been experiencing an intensifying funding squeeze in recent months as fears have grown over their exposure to potentially toxic eurozone periphery sovereign debt. The Continent's banks have around €720bn worth of their own bonds that they need to roll over next year.

The €489bn borrowed from the Frankfurt-based central bank was considerably in excess of the €250bn to €350bn that had been expected by analysts. The ECB lending programme, first unveiled by the central bank's new president, Mario Draghi, earlier this month, is designed to reduce the likelihood that a large private bank will run out of cash next year and be forced into a catastrophic default.

Yesterday's offer was the largest sum allocated in an ECB liquidity operation since €442bn in one-year loans were snapped up by banks in June 2009. "This is good. It's a positive number, at the top end of expectations. You have to regard it as a positive result," James Nixon at Société Générale said.

Some European politicians, including the French President, Nicolas Sarkozy, have voiced hopes that private banks will use the cheap funds to buy up the sovereign bonds of struggling nations such as Italy and Spain and thus help to stabilise the eurozone debt crisis. Deutsche Bank estimates that banks used about half of the €442bn they borrowed from the ECB in 2009 to buy up Greek and Spanish sovereign bonds.

But analysts were divided over whether this was likely to happen. "Small banks may be tempted to invest the proceeds of the auction into sovereign bonds, profiting from the huge interest rate differentials," Christian Schulz, of Berenberg Bank, said. Annalisa Piazza, of Newedge Strategy, said larger banks are also likely to attempt to benefit from the "carry trade" of buying high-yielding peripheral debt with cheap ECB loans . "Given the large number of banks participating at today's auctions, we cannot rule out some core countries' banks have started to put on some carry positions," she said.

Yet other analysts were sceptical about whether banks would see this as an attractive strategy. "We doubt whether the money will be used extensively to fund purchases of peripheral debt, given concerns about mark-to-market risks and possible reputational risks," Martin Van Vliet of ING said.

And Giovanni Sabatini, of the Italian banking association, said that the recent actions of the European Banking Authority (EBA), which has required banks that hold large sums of peripheral eurozone debt to raise more capital, would act as a disincentive against banks loading up on new European government bonds. "The EBA rules are a deterrent for buying sovereign bonds," Mr Sabatini said. "Not even the ECB's important liquidity injection can be used to support sovereign debt. Banks not only will not increase their exposure, but they will probably cut it."

Ratings agency's threat to US AAA status

The United States was warned that its rising debt threatens its AAA status yesterday, as Hungary became the latest European nation to see its credit rating downgraded.

Fitch Ratings warned again that the United States' rising debt burden was not consistent with maintaining its top AAA credit rating, but said there would likely be no decision on whether to cut the rating before 2013. Last month, Fitch changed its US credit rating outlook to negative from stable.

Meanwhile, Standard & Poor's lowered their long and short-term credit ratings on Hungary one step to BB+ from BBB-, placing the ratings into the non-investment grade, or junk, category.