London: Five central banks acted on Thursday to shore up confidence in Europe's financial system by giving its banks far greater access to US dollars.
The move buys time for banks that hold large amounts of debt issued by Greece and other financially troubled European countries. Some of these banks have had trouble paying for daily operations because other banks have refused to lend to them any more.
Under Thursday's action, the banks can borrow unlimited dollars for three months, up from the current one-week limit.
The European Central Bank said it will coordinate with the US Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank to offer the loans through the end of this year. Their move to supply more dollars is similar to steps taken during the 2008 financial crisis and again in May 2010.
The news reassured stock markets, which have been battered by rumors that banks' losses on their loans to Greece might sink them. Stock indexes in France and Germany each surged 3.1 per cent. The euro rose against other currencies. US indexes rose by more than 1 per cent.
Concern about their access to dollars has been a key reason why European banking stocks have been beaten down. Investors have been particularly worried about big French banks Societe Generale and BNP Paribas. Thursday's news sent Societe Generale's stock soaring 8 per cent and BNP Paribas' 13 per cent.
Analysts cautioned that the expanded credit line for dollars isn't a long-term solution to Europe's debt crisis. Greece still appears likely to default on its debts. If it did, some banks could topple. Panic might spread among global investors.
The move will likely ward off a panic for the next few months, said Mark McCormick, currency strategist at Brown Brothers Harriman
"But it's not going to solve the problem, which is too much debt," McCormick said.
Still, he said the central banks acted wisely to address the problem now, before pressure on banks intensifies further.
When a bank is rumored to be in danger of suffering large losses, other banks will stop lending to it for fear of not getting their money back. That's the scenario that led to the global credit crunch in 2008. Banks will then stop lending to businesses. The funding squeeze stifles growth and hurts the global economy.
Indicators of banking stress are at their worst points in three years, McCormick said. Still, they remain better than before Lehman Brothers failed exactly three years ago - on September 15, 2008 - setting off a worldwide credit crisis.
The coordinated effort is intended to prevent Europe's debt crisis from derailing the global economy's rebound from recession. That topic will dominate talks between US Treasury Secretary Timothy Geithner and his European counterparts at a meeting in Poland starting on Thursday night and running through Saturday.
Daniel Alpert, managing partner at the New York investment bank Westwood Capital LLC, said the move allows European policymakers to work through the end of the year to prevent a Greek default from upending the global financial system.
"They're gearing up to allow an orderly default" by Greece and to prop up banks that suffer big losses on bonds issued by Greece and other financially ailing countries, Alpert said.
It provides "some time to put institutional firewalls in place so that the whole place doesn't melt down," he said.
Financial markets have been gyrating wildly for weeks on fears that Europe's debt crisis will spin out of control and imperil Europe's banking sector. Moody's ratings agency this week downgraded Societe Generale and BNP Paribas on those concerns.
McCormick said the long-term impact of Thursday's move was uncertain.
For most of the past decade, Greece has run up budget deficits well beyond limits set by the European Union, a group of 27 nations that allow goods and workers to cross their borders freely.
Should Greece default, investors will worry that two much larger EU members, Italy and Spain, might follow. Just the fear that this could happen has led investors to sell those countries' bonds. That selling pressure would drive up yields on those bonds and make it increasingly expensive for that country to borrow. Their financial mess could worsen.
Given Germany's reluctance to bail out Greek banks, Alpert said, other EU nations may choose to prop up their own banks and allow Greece to default.
US banks hold much less in Greek government bonds than European banks do. But the 2008 financial crisis showed that dangers can lie in unexpected places. Some US banks, for example, have sold investors insurance that would require them to pay billions if Greece, Ireland or Portugal defaulted. Others have lent heavily to European banks that might teeter if Greece can't pay its debts.
Investors will now focus on the talks in Wroclaw, Poland. There, the eurozone's financial chiefs and Geithner are huddling to find more lasting solutions to the debt crisis.
The European ministers are expected to finalize the terms of Greece's second bailout. It had initially been agreed upon in July. But it ran into difficulties after Finland demanded extra guarantees for lending Athens money. That sparked a rush of demands from other small eurozone nations.
The ECB hopes the dollar loans will ease the pressure in the short term. The loans will be made in October, November and December at fixed interest rates and for unlimited amounts as long as the bank demanding the loan has collateral.
In Washington, Christine Lagarde, managing director of the International Monetary Fund, called the central banks' move "exactly what is needed" to demonstrate a willingness to engage in a coordinated response to the European debt crisis.
"It shows they will do what it takes to maintain stability in the financial system," Lagarde said in an interview on CNBC TV.
Under the program, the Fed provides dollars requested by the ECB. The ECB distributes that money to commercial banks in Europe. There's no cap on the dollars the Fed can provide. The Fed will receive euros to hold in return for the dollars and will get interest payments on the dollars it provides the ECB.
The Fed's exposure will be to the ECB, not to the commercial banks. And the ECB will be obligated to repay the Fed in dollars.
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