ECB handout carries risks of renewed bank backlash

March 5, 2012

By Peter Thal Larsen

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Banks should be wary of Mario Draghi’s gifts. The president of the European Central Bank has averted economic disaster in the euro zone and sparked a broad market rally by spraying financial institutions with 1 trillion euros of cheap money. But if the real economy does not share in the benefits, banks may face a renewed backlash.

The ECB’s three-year loans have removed the risk of a euro zone lender running out of cash and sharply reduced the chances of a credit crunch. They have also given banks an incentive to buy sovereign debt, helping the euro zone’s cash-strapped governments.

But the loans carry political and reputational risks by facilitating some fast-buck trades, such as using ECB funding that costs 1 percent a year to buy Italian or Spanish bonds yielding almost five times as much. The temptation for banks will be to divert some of those earnings into employees’ pockets.

Banks are already trying to head off any suggestion that traders may be wrongly enriched by the ECB. Barclays said on March 2 that any financial gains from taking some 8.2 billion euros of ECB liquidity would be excluded from its bonus pool. Rival HSBC had already announced the same policy.

In reality, the direct benefit of the ECB loans is relatively small. For Barclays, borrowing from the ECB is about 67 basis points cheaper than it would have to pay for secured debt with a similar maturity. That implies an annual boost to income of 55 million euros – or about 165 million euros over the duration of the ECB facility.

The bigger difficulty is that Barclays and others have also benefited from an ECB-inspired rally that has lifted the value of assets on their balance sheets, stimulated trading volumes and bond issuance, and boosted the value of the deferred shares that account for the majority of senior investment bankers’ pay. Those gifts will be harder to strip out from the bonus pool.

A sustained recovery in the euro zone clearly depends on banks becoming healthier. That revival is still some way off: overnight deposits by commercial banks with the ECB have hit a record 777 billion euros. If banks and bankers start popping champagne while the rest of the economy is in rehab, they can expect politicians to explore new ways to stop the fun.

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