September 16, 2014 / 1:49 PM / in 3 years

ECB invites banks to tap new funds it hopes will pep up euro zone

The new European Central bank (ECB) headquarters are pictured in Frankfurt, September 11, 2014.Ralph Orlowski

FRANKFURT (Reuters) - The European Central Bank invited banks on Tuesday to bid for a fresh round of long-term loans it hopes will stimulate lending to businesses and reinvigorate the euro zone economy but which may see only modest take-up.

The program is a key plank of ECB efforts to stave off the threat of deflation and breathe life into the euro zone economy, which stagnated in the second quarter. At 0.3 percent, inflation is running well below the ECB target of just under 2 percent.

The ECB will announce how much it is granting banks in the new loans at around 5:15 a.m. EDT on Thursday, doling out the fresh cash just as the cheap three-year long-term loans - or LTROs - that it issued in late 2011 and early 2012 approach expiry.

The new targeted funds, or TLTROs, will also offer banks long-term funding at interest rates close to zero, but will be tied to lending to the mostly smaller firms that are the euro zone's economic backbone.

Analysts are skeptical the operation will boost lending.

"It doesn't matter how much liquidity you give banks. They will still not lend," said Fabio Ianno, a banking expert with ratings agency Fitch.

Fitch believes the weak state of many companies in southern Europe and subdued demand means banks have little appetite to issue corporate loans in the region.

ECB President Mario Draghi said earlier this month he wanted the TLTROs, together with a new ECB asset-purchase program, to swell the central bank's balance sheet - an exercise aimed at freeing up the flow of credit and stimulating the economy.

Draghi said he wanted the balance sheet to get back to levels seen in early 2012 - up to a trillion euros higher than its present size.

"If the name of the game here is bigger balance sheet, I'm sceptical we'll get much," RBS economist Richard Barwell said of the initial TLTRO operation.

FIRST SHOT

This week's operation is banks' first shot at the TLTROs.

Under the plan, they can borrow up to 400 billion euros ($517.67 billion) at tenders this week and in December at a slight premium to the ECB's regular funding operations, with opportunities running through to mid-2016 to take additional loans.

A Reuters poll of 20 money market traders pointed to banks taking over three quarters of the sum on offer, snapping up 133 billion euros at Thursday's offering and a further 200 billion on Dec. 11.

"That doesn't feel like it would be a game-changer for the balance sheet, which then puts more pressure on the program Draghi announced earlier this month," said Barwell.

Under that program, the ECB plans to buy asset-backed securities (ABS) and covered bonds to help ease credit conditions in the euro zone.

Under the TLTRO plan, banks that have shown positive net lending between April of this year and the new funding operation can borrow up to three times their net new lending in that window and keep the money until 2018, so long as they beat a certain benchmark for lending set for them.

The terms of the plan do not stipulate, however, that banks must devote all the ECB loans to new lending.

The idea is that one or more of three things will happen. Banks may use the money to lend to households and businesses, thereby directly helping to revive the economy, or take the money and buy assets themselves, or use the funds to substitute for issuing their own debt.

The latter two could lower the funding costs for all banks, even those who don't take the ECB's money, and spill over into looser conditions in the broader corporate credit market, making money cheaper and easier to access.

Making the TLTROs more attractive, the ECB cut interest rates to record lows at its Sept. 4 meeting and said it would not reduce them any further - so later shots at the TLTROs would not come at more favorable terms.

Draghi said the rate cut "signals to the banks that are going to participate in the TLTRO that they should not expect any further lowering in interest rate, so they should not hesitate to participate in the TLTRO because of this reason".

Indeed, locking in the TLTRO funds for four years would offer banks a kind of insurance against any potential interest rate hikes over that timeframe.

Getting the funds to flow to businesses is another matter.

"I don't think the money will flow to the real economy." said Ianno at Fitch.

Additional reporting by John O'Donnell; Editing by Catherine Evans

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