The European Central Bank has been at the centre of efforts to relieve the pressure of the eurozone crisis, cutting interest rates and introducing two crucial measures to boost liquidity in the banking sector. These actions have brought sovereign borrowing costs down sharply, particularly for Italy, Spain, Austria, and France.
But in a note out yesterday, Morgan Stanley writes that investors are still underestimating the true impact of the LTROs.
Their reasoning? “By taking bank funding risk off the table for a couple of years in Europe, the ECB has significantly reduced the risk of a systemic banking crisis, which we were highly concerned about in 2H 2011.” Further, their predictions largely undercut expected participation in the deal.
European banks remain the nexus of the European sovereign crisis as well as the major problem in themselves. We’ve regularly argued that European policy makers have repeatedly underestimated bank funding as a transmission mechanism of sovereign fears into the real economy and act as a negative feedback loop on the sovereign. With the massive ECB and central bank intervention we think we are entering a new chapter. With interest rates now profoundly low in the Western world with little room for further easing, as our economics colleagues have written, and banking systems impaired, policy intervention in the banks is becoming ever more important for monetary and credit transmission. That’s why we think understanding and anticipating policy and the health of banks will remain one of the most important aspects for investing across multiple asset classes.
In particular, the LTRO allowed banks to pre-fund the majority of their debts in 2012 and even into 2013.
[credit provider=”Morgan Stanley”]
This doesn’t necessarily speak for the health of these banks in the long term, however it does suggest that the ECB has made sharp steps to revive credit markets and lending capacity in the short term, particularly amid the strict new capital requirements the European Banking Authority is imposing.