European Central Bank readies new cash bonanza for banks

(FRANKFURT) - The European Central Bank again plays firefighter in the eurozone debt crisis on Wednesday, with cheap financing for banks as tensions return over the Spanish budget and Germany's stand on a crisis fund.

The ECB is expected to flood eurozone banks with more cheap cash to avert a credit squeeze in the single currency area where tension has eased in the light of an almost complete second rescue for Greece.

However, analysts on financial markets warn that the new-found confidence is fragile, and aversion to risk on the interbank market remains high.

On Tuesday, the European Union cancelled talks at its summit at the end of this week on a crisis fund for the eurozone because of German reticence about boosting the funding.

And the European Commission warned Spain over serious slippage in controlling its public deficit.

Meanwhile, Ireland said that it would have to hold a referendum on the so-called golden rule which most EU countries want to introduce to control national budgets.

Under recent measures, the ECB has already decided to lend as much as banks wanted at a rock-bottom interest rate of 1.0 percent for a period of three years so as to keep credit flowing.

At the first such long-term refinancing operation (LTRO), about 523 banks lined up to borrow a record 489.2 billion euros ($658 billion).

While some analysts believe the banks could borrow as much as 1.0 trillion euros at the second, and most likely last, three-year LTRO on Wednesday, the majority are more conservative and forecast a similar amount to the first.

The ECB is scheduled to announce the results at around midday on Wednesday.

Luca Cazzulani at UniCredit Research said he was pencilling in total demand at around 450 billion euros.

Commerzbank analyst Carolin Hecht said the market consensus was for roughly the same volume as last time.

"If the volume is around this level the effect on euro-dollar exchange rate is thus likely to be neutral to moderately positive," she said.

The euro was changing hands at 1.3460 dollars in mid-morning on Wednesday.

Fabio Fois at Barclays Capital Research said he did not expect the volume to be above the take-up in December.

"This has the potential to keep market sentiment positive, but is unlikely to have the same catalyst impact as the first three-year LTRO, given the significant performance of the risky assets over the past few months," Fois said.

Tensions in the banking system appear to have eased as a result of the first LTRO, suggesting that the approach may be working, at least for now.

Borrowing costs for debt-wracked countries such as Spain and Italy have come down, stock markets across Europe have rallied and confidence is on the rise although a final resolution of the eurozone debt crisis seems some way off yet.

The offer on Wednesday could be skewed, however, by the ECB's announcement on Tuesday that it will temporarily refuse to accept Greek government bonds as collateral for loans after rating agency Standard & Poor's declared that Greece is in "selective default".

That will make it harder for Greek banks in particular to take advantage of the new ultra-cheap loans because in order to qualify for them, banks must put up collateral, including in the form of sovereign bonds.

Nevertheless, any banks unable to do so because of the suspension of the Greek bonds will still be able to borrow cash from their national central bank under emergency assistance provisions, the ECB said.

Ever since the eruption of the debt crisis, the ECB has come under intense political pressure to step in and save eurozone countries sinking under huge mountains of debt.

But the bank has argued from the very beginning that it is up to overspending governments to get their finances in order and restore the markets' confidence in their ability to repay their debts so as to remedy the underlying cause of the eurozone's current ills.

While ECB chief Draghi said the aim of the new funding was for banks to lend to households and businesses, there have been concerns that banks are simply hoarding the cash instead.

For weeks, the banks have been parking record amounts of cash in the central bank's overnight storage facility, earning paltry returns rather than take the risk of lending the funds on to earn more.