Money markets more ecb cash might not unlock lending

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Any further offer of cheap cash to banks by the European Central Bank might increase liquidity in the euro zone's banking system but is likely to have little impact on lending to the wider economy. ECB Governing Council member Luc Coene said on Monday that extending the central bank's long-term refinancing operations (LTROs) was one of several options available should it wish to loosen monetary policy further to ease Europe's debt crisis. To try and tempt banks into new lending, he suggested the ECB could accept private credit claims - typically loans to firms and households - as collateral.."The focus is on trying to get banks to lend to the non-financial sector and this is more evidence that this is what the ECB is thinking about," said Morgan Stanley's global head of interest rate strategy Laurence Mutkin. Banks' borrowing from the ECB has stabilised since the central bank held its second three-year cash offer at the end of February which took banks' borrowing from it at maturities of more than three months to over a trillion euros. On top of that, lenders are taking around 120 to 130 billion euros in weekly funding, according to ECB data.

"The theory is that if banks want to access this facility they'd have to lend in order to have the collateral they would need at such a lending window," said Rabobank rate strategist Richard McGuire. The problem is that although banks have borrowed a vast amount from the ECB, the money is failing to reach the wider economy where it could stimulate spending and growth. Regulatory requirements to hold more capital combined with tighter lending criteria means that banks are holding onto cash.

Over 400 billion euros above and beyond that necessary to meet the ECB's average reserve requirements is being left at the ECB each night, Reuters data shows. ECB money supply data has also shown that a credit squeeze has persisted this year despite all the efforts to provide liquidity, with private sector lending slowing. The most recent figures showed loans to households in the euro zone fell in July, reflecting weak domestic demand, while loans to companies ticked up only slightly.

Meanwhile, research by JPMorgan shows that although central bank balance sheets in the United States, the euro zone, Japan and Britain have expanded by around 125 percent since August 2008, money supply has only increased by 33 percent."Major developed economies are in a 'liquidity trap', the bank's global asset allocation team wrote in a recent note. "Central Banks are creating reserves but this does not increase the money stock as bank lending remains weak."But money supply is in line with demand, JP Morgan concluded, suggesting that potential borrowing remains subdued. Morgan Stanley's Mutkin said factors may be inhibiting banks' willingness to lend that are unlikely to be solved by the ECB providing more cash."Banks are thinking about their credit rating, their shareholders and creditors and ... what these stakeholders think is the right size of balance sheet to have," he said."So it's not the case the ECB can (offer more liquidity) and change banks' behaviour, but it is further evidence they will try lots of things to make this work."