Eurozone: Big banks on dope

Here is the euro crisis in a nutshell.

Investors and creditors worried that certain eurozone countries with big debts would struggle to repay what they owe. This fear focussed on Greece first, and is still most acute in its case, and spread to Ireland, Portugal, Spain and Italy.

Then the anxieties about solvency and liquidity spread to the eurozone's banks - because banks were big creditors of the very countries struggling to repay what they owe, because many of these banks were perceived to have insufficient capital to absorb losses and because in extremis any bank is only as strong as the government standing behind it.

In the autumn, the eurozone banking system moved quite close to collapse, in the most extreme phase of the currency union's crisis, because investors and creditors were shunning them, refusing to lend to them.

But the European Central Bank rode to the rescue in late December, taking the place of the private-sector institutions refusing to lend to the eurozone's bank - by providing an unprecedented 489bn euros of three-year loans to European banks, to prevent them falling over for want of access to vital credit.

And since then, banks in general have found it a little easier to borrow. And financially stretched governments, such as those of Italy and Spain, have found it a little easier and cheaper to borrow.

Crisis over?

Errr, not really. Because all that has happened is that a public-sector lender to the banking system, the European Central Bank, has replaced private sector lenders to the banking system.

In fact if you think that the eurozone's fundamental problem is that its public sector has borrowed too much, you might question whether making private-sector banks more dependent on public sector credit (from the European Central Bank) solves anything at all, in a fundamental sense.

Or to put it another way, all that the three-year loans provided by the ECB achieves is to buy some time - for banks to recapitalise and strengthen themselves, and for governments to do more-or-less the same thing. And, of course, at best that restoration of the solvency of governments and banks is work in progress.

If you want a little vignette on the surreal nature of the ECB's rescue operation, it is that Italian and Spanish banks were the biggest takers of the central banks' three-year loans - respectively borrowing 30% and 15% of the net new money according to Morgan Stanley - and then promptly used more than 40bn euros of their ECB debt to lend to their respective governments.

So you could say that the ECB was lending to the Spanish and Italian governments - getting round its prohibition on making such sovereign loans - via the Spanish and Italian banks.

But maybe we should not worry our heads that the underlying health of the patient hasn't improved.

Like a concerned relative, maybe we should just be relieved that the eurozone is on very powerful painkillers and looks quite a lot better, on the surface - and we've just got to keep our fingers crossed that in the weeks and months ahead Greece and Portugal don't default, and creditors' confidence improves in relation to the rebuilding of the public finances of Spain, Italy and Ireland.

Anyway, all of this is a pre-amble to today's administration of another powerful dose of ECB painkillers, in the form of a second round of three-year loans to the banks. For what it's worth, my sense is that markets will be pleased if the banks take more of the ECB's money rather than less - because investors appear to want to see the banks as willing patients, and because the more money taken by the banks, the more will seep through to those governments which have been struggling to borrow.

So I would imagine that if the banks borrow another 500bn euros or so, that would be seen as a good sign - and less than 350bn euros would probably not go down well.

Investors don't want to see banks gritting their teeth and heroically rejecting the ECB's morphine. They would rather they took all the financial opiates on offer - because, who knows, in their dosed up state, the eurozone's banks might even start lending a bit more to the real economy.

UPDATE 10:55 GMT

So the European Central Bank has provided just under €530bn of three-year loans to the European Union's banks, which was at the top end of expectations.

That lifts the gross provision of these longer-term loans to over a trillion euros. My calculation is that this represents a net injection of new central bank loans into the eurozone banking system of just under 650bn euros (the gross three-year loans, minus the repayment of shorter term ECB loans).

The lending exercise represents a massive, perhaps unprecedented, expansion of the ECB's balance sheet. But as I mentioned earlier, the view of investors currently appears to be that they wanted European banks to take as much of these cheap ECB loans possible - to minimise the risk that banks won't be able to refinance 1.8 trillion euros of their private-sector debts that fall due for repayment between now and 2015, and to channel funds to cash-strapped Italy and Spain.

UPDATE 14:35 GMT

I overstated net new lending by the ECB via the second auction of three-year loans. The net lending is €300bn, taking the total for the two auctions to half a trillion euros.

The relaxation of collateral requirements allowed many more banks to get the money - 800 banks in the second auction, versus 500 in the first. It probably means that smaller cash-strapped banks have tapped the ECB this time.

And there appears to have been little stigma attached to taking the money, in that Lloyds and RBS have both taken some of the three-year cash - and reports suggest that Deutsche bank has done too.

Perhaps most significantly, Spanish and Italian banks are again the biggest borrowers by far. And the investment bank, Morgan Stanley, believes that what the Spanish banks have borrowed would allow them to finance all the borrowing needs of the Spanish government for the coming year, and the Italian banks could finance half Italy's funding requirement in 2012.

So, as I mentioned earlier, this is a pretty powerful painkiller, or an enormous piece of sticking plaster, if not a cure.