By JACK EWING
Published: February 12, 2012
FRANKFURT — Few would begrudge Mario Draghi his boast last week that he and the European Central Bank had prevented a disastrous credit crisis by showering banks with cheap loans in December.
But beneath the gratitude toward Mr. Draghi, the president of the central bank, lurks a fear that the easy money could simply be creating the conditions for another banking crisis several years from now.
Because of the central bank’s cheap financing, some economists warn, sick banks now face less pressure to confront their problems — to clean out bad loans and other impaired assets, or even wind down operations if there is no hope of a turnaround. The European Central Bank, they say, could inadvertently spawn a cohort of “zombie banks,” burdened by nonperforming loans and assets that remain on the books, like the ones that helped make the 1990s a lost decade for Japan.
“It’s a huge bet,” said Charles Wyplosz, a professor of economics at the Graduate Institute in Geneva. “If the crisis ends up well, the E.C.B. will have pulled off a miracle. If things go wrong then commercial banks will be in a much worse situation than they were before.”
Professor Wyplosz said the central bank might be making the banking system more fragile by encouraging institutions to load up on risky assets, especially government bonds from troubled euro zone countries like Spain or Italy. Banks can use those assets as collateral for more loans from the central bank.
In December, the European Central Bank invited banks to borrow money at the benchmark interest rate of 1 percent for three years, compared with a previous maximum maturity of one year. Banks could borrow as much as they wanted provided they posted collateral. They jumped at the opportunity: 523 banks borrowed 489 billion euros, or $647 billion.
The central bank will offer another round of three-year loans at the end of this month, and last Thursday it loosened its collateral rules to encourage smaller banks to join in. According to some predictions, banks may draw on the cheap credit even more enthusiastically than they did in December.
Last Thursday, Mr. Draghi urged banks to take the money, and even ridiculed top bankers who have bragged they did not need the central bank’s charity. “I would describe some of the statements made as ‘statements of virility,’ ” Mr. Draghi said at a news conference in Frankfurt. “The three-year facilities are there to be used.”
The cascade of cash has lifted sentiment in the euro zone, and may even help the region avoid a serious economic downturn. But it is not yet clear how banks are using the money, and whether they will spend it wisely. Some banks — no one knows how many — are bound to use it to cover up past mismanagement and books full of bad assets.
“It’s like taking medicine, it sometimes has side effects,” said João Soares, a partner at Bain & Company, the management consulting firm, who specializes in financial services. “One side effect that is not good,” he said of the central bank’s lending, “is that it removes pressure to clean up balance sheets.”
As the experience of Japan showed in the 1990s, zombie banks tended to keep lending to troubled borrowers to avoid recognizing losses from bad loans. As a result, the healthiest and most productive companies struggled to find credit.
“Zombie banks support zombie companies,” said Nicolas Véron, a senior fellow at Bruegel, a research organization in Brussels. “Zombie banks will not extend credit to borrowers that need it. This is bad for the economy.”
Mr. Véron said he believed the central bank was aware of the risks but had no other alternative as long as governments like Italy or Spain were struggling to regain investor confidence.
“Banks need to be on life support even if it keeps alive zombie banks,” he said. “I’m convinced the E.C.B. has no illusions about the downside of this policy.”
Published: February 12, 2012
FRANKFURT — Few would begrudge Mario Draghi his boast last week that he and the European Central Bank had prevented a disastrous credit crisis by showering banks with cheap loans in December.
But beneath the gratitude toward Mr. Draghi, the president of the central bank, lurks a fear that the easy money could simply be creating the conditions for another banking crisis several years from now.
Because of the central bank’s cheap financing, some economists warn, sick banks now face less pressure to confront their problems — to clean out bad loans and other impaired assets, or even wind down operations if there is no hope of a turnaround. The European Central Bank, they say, could inadvertently spawn a cohort of “zombie banks,” burdened by nonperforming loans and assets that remain on the books, like the ones that helped make the 1990s a lost decade for Japan.
“It’s a huge bet,” said Charles Wyplosz, a professor of economics at the Graduate Institute in Geneva. “If the crisis ends up well, the E.C.B. will have pulled off a miracle. If things go wrong then commercial banks will be in a much worse situation than they were before.”
Professor Wyplosz said the central bank might be making the banking system more fragile by encouraging institutions to load up on risky assets, especially government bonds from troubled euro zone countries like Spain or Italy. Banks can use those assets as collateral for more loans from the central bank.
In December, the European Central Bank invited banks to borrow money at the benchmark interest rate of 1 percent for three years, compared with a previous maximum maturity of one year. Banks could borrow as much as they wanted provided they posted collateral. They jumped at the opportunity: 523 banks borrowed 489 billion euros, or $647 billion.
The central bank will offer another round of three-year loans at the end of this month, and last Thursday it loosened its collateral rules to encourage smaller banks to join in. According to some predictions, banks may draw on the cheap credit even more enthusiastically than they did in December.
Last Thursday, Mr. Draghi urged banks to take the money, and even ridiculed top bankers who have bragged they did not need the central bank’s charity. “I would describe some of the statements made as ‘statements of virility,’ ” Mr. Draghi said at a news conference in Frankfurt. “The three-year facilities are there to be used.”
The cascade of cash has lifted sentiment in the euro zone, and may even help the region avoid a serious economic downturn. But it is not yet clear how banks are using the money, and whether they will spend it wisely. Some banks — no one knows how many — are bound to use it to cover up past mismanagement and books full of bad assets.
“It’s like taking medicine, it sometimes has side effects,” said João Soares, a partner at Bain & Company, the management consulting firm, who specializes in financial services. “One side effect that is not good,” he said of the central bank’s lending, “is that it removes pressure to clean up balance sheets.”
As the experience of Japan showed in the 1990s, zombie banks tended to keep lending to troubled borrowers to avoid recognizing losses from bad loans. As a result, the healthiest and most productive companies struggled to find credit.
“Zombie banks support zombie companies,” said Nicolas Véron, a senior fellow at Bruegel, a research organization in Brussels. “Zombie banks will not extend credit to borrowers that need it. This is bad for the economy.”
Mr. Véron said he believed the central bank was aware of the risks but had no other alternative as long as governments like Italy or Spain were struggling to regain investor confidence.
“Banks need to be on life support even if it keeps alive zombie banks,” he said. “I’m convinced the E.C.B. has no illusions about the downside of this policy.”
