Bank Lending Stress in Euro Region Experience Unprecedented Fall Because Of Draghi’s Cash Triggers

The decision of Mario Draghi, the President of European Central Bank to offer $1.3 trillion worth cheap loans to stand behind Euro has pushed the indicators of stress in Europe’s money markets down by a huge margin this year. The difference between the offered rate by Euro Interbank and overnight index swaps (Also known as the Euribor-OIS spread) has contracted by 0.85% in 2012 and is at 0.12% currently. This marks a record decrease in this index which measures the reluctance of European banks to offer unsecured loans to each other.

Incidentally, the $1.3 trillion loan was offered as part of the longer-term refinancing operation which was started in December, 2011. This operation attempts to provide cheap and unlimited amount of cash to the lenders, so that the overall economy of this region can get a boost. According to the Interest Rate Strategist of ICAP Plc., Chris Clark, the key catalyst behind this contraction in the index for 2012 was Draghi. Clark added that the three-year LTROs also played an important part in decreasing the index.

4 years ago, the Euribor-OIS Spread was around 2.07% and since then, the same has narrowed down. The spread saw an increase in both 2010 and 2011. However, this year’s decrease is expected to beat the 84.5 basis point drop that this index experienced in 2009. The index, which is determined through daily surveys done on the European Banking Federation member banks, is going to have its 1st annual decline in the last 4 years.

According to economists, to reduce the money-market stress indicators, the low interest rates also played a major part. Incidentally, on 6th December, European Central Bank decided to keep the major refinancing rate at 0.75%, an all-time low. Additionally, last month, Draghi stated that the risk of inflation is very low and also hinted that the reductions would be put back on the agenda. Lower interest rates cause trouble for the money-market funds that invest in Europe, however, the borrowing costs of a bank gets aided.

On the other hand, the Overnight Index Average of Europe of unsecured lending deals (Also known as Eonia) reduced by 0.06%. The estimate of overnight borrowing costs for the next quarter, measured through the Eonia swap has also plummeted by 31.5 basis points, as measured.