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ECB: Don’t hold your breath for LTRO 3

ECB’s Praet says liquidity provision “a delicate balancing act”

Any eurozone banks anxiously waiting for a third helping of cheap European Central Bank (ECB) liquiditywill have been listening carefully to the words of Peter Praet, member of the executive board of the ECB, at the International Capital Market Association AGM in Milan on Friday.

“You have to find the right balance when you provide liquidity – in our case particularly to the banking sector,” warned Praet. “We want to smooth the process but not to slow down initiatives for reform. All we hear from the banks is, ‘Give us more time, give us more time.’ The idea [behind liquidity provision] is to smooth the unavoidable deleveraging of the banking system and to avoid fire sales but at the same time we have to operate a very delicate balancing act.”

This was very far from a commitment to further smooth bank deleveraging by the provision of another round of three-year refinancing loans. But others at the meeting believe such a move will be unavoidable. “We will have LTRO 3 very soon,” predicted Robert Parker, head of the strategic advisory group at Credit Suisse.

Praet is well aware of the unintended consequences of the raft of regulatory reform that has been proposed. “Ambitious reforms are now being undertaken to make the system as a whole more resilient and less procyclical,” he says. “But the reality has been that there are signs of the procyclical consequences of the regulatory agenda.”

Mario Draghi, President of the European Central Bank

Of particular concern are national constraints now being put on cross-border institutions that prevent them operating in an integrated way. “This is leading to constraints on the internal capital markets of cross-border firms – ring-fencing by another name,” says Praet. A pan-European crisis resolution mechanism is urgently needed and described as indispensible by Praet to allow markets to function properly, but he notes: “This is clearly lacking and it is very difficult to do.”

The intensifying sovereign debt crisis is weighing heavily on the ECB: its balance sheet is now 35% of eurozone GDP. Praet expressed frustration that social and political issues are causing what in many cases are manageable problems to become critical.

“There are no miracles out there and governments have to restore credibility,” he said. “If you look at some of the numbers, it is not so hard. In Spain, for example, the debt service ratio is now 3.5% to 4% of GDP. At its peak, it was 11%. For some countries the weight of debt service is relatively manageable – for others it clearly is not. But in many cases it is feasible to get it under control in a relatively short period of time.

“The problem is political. There is no trust in the capacity of society to find a social and political consensus.”