(See TOP CRIS for more on Europe’s debt crisis.)
Oct. 4 (Bloomberg) -- European Central Bank Executive Board member Benoit Coeure said that loans provided to the financial system shouldn’t be a substitute for any capital shortage.
“Liquidity ought to be provided to the banking system as needed,” Coeure said yesterday in a speech in Toulouse, France. “But it should not be a substitute for a lack of capital.”
ECB President Mario Draghi said on Oct. 2 that the Frankfurt-based central bank stands ready to deploy instruments such as another round of long-term loans to banks if needed. At the same time, liquidity “should not be a replacement for lack of capital,” he said.
Central banks acting as lenders of last resort “can generate moral hazard in the banking system, lead central banks to take unwarranted credit risk and, in some extreme cases, interfere with their primary mandate –- price stability,” Coeure said. “Support that is considered as appropriate during the crisis might have perverse effects on the incentives of banks at a later stage.”
Euro-area banks are repaying three-year loans made at the height of the sovereign debt crisis. While that’s draining cash, Draghi has backtracked from an earlier signal that excess liquidity should stay above 200 billion euros ($273 billion). Instead, the ECB has pledged since July to keep interest rates at or below current levels for an “extended period,” helping to keep the cost of bank funding down.
The ECB provided banks with more than a trillion euros in three-year loans in late 2011 and early 2012 as a credit crunch threatened, with the option to repay them early. Lenders have since paid back nearly two-thirds of the original net increase in funding, in part because the ECB’s OMT bond-buying plan in September 2012 helped calm fears that the euro area would break apart.
Draghi has asked an ECB panel to study options for new bank funding measures as policy makers try to figure out how to deal with any future liquidity shortages, two euro-region central bank officials said on Oct. 2, asking not to be identified because the matter is confidential. The panel has no set date for delivering a verdict, one official said.
“There is a fine line between liquidity and solvency needs, which in a crisis is often blurred,” Coeure said. “Central banks should therefore be particularly wary not to substitute for capital support that should be provided by shareholders, investors, or in last resort by governments.”
--Editors: Zoe Schneeweiss, Andrew Langley