The European Central Bank allotted €489.19 billion ($639.96 billion) in the first of two keenly-awaited three-year refinancing operations Wednesday, beating market expectations in a sign that banks expect other sources of funding to remain tight through 2012.
The result will fuel hopes that banks might use the funds to prop up euro-zone sovereign bond markets.
The ECB said it allotted the three-year loans—the longest maturity ever offered by the central bank—to 523 banks. The amount allotted was the most ever for a longer-term refinancing operation, exceeding the previous record of €442 billion set at the June 2009 one-year auction.
At a separate three-month refinancing operation Wednesday, the ECB allotted €29.74 billion to 72 banks.
The news had a positive impact on the markets, with the CAC-40 in Paris recently up 1.3% at 3094.29, having climbed initially to 3121.29. Frankfurt's DAX 30 had added 1.2% to 5917.95, just off the day's 5965.35 high, while in London the FTSE 100 had gained 0.6% to 5451.18.
The euro made a new high for the day, and the week, of $1.3199 in the aftermath of the announcement, but has slipped back a few ticks since, recently trading at $1.3138.
The record refinancing allotment comes as the ECB aims to head off a potential credit crunch and economic slowdown or even recession next year by providing unlimited liquidity to euro-zone banks.
Many analysts had expected demand for the three-year loans to exceed €300 billion as banks sought to secure long-term funding amid deepening strains on interbank markets.
Some market participants believe that the new funding facility might encourage private banks to buy their government's debt or hold on to existing sovereign bonds, reducing pressure on the ECB itself to support sovereign bond markets.
"Due to the interlinkage between banks and their governments, banks could potentially save themselves by saving their sovereigns," said Christian Schulz, an economist at Berenberg Bank in London.
Strong demand at Tuesday's successful Spanish treasury bill auction signalled that the enhanced liquidity may already be helping some peripheral debt markets, as the government raised more funds than planned and at a lower cost than at its previous outing.
ECB President Mario Draghi reiterated Monday that he hopes the new liquidity measures will restore credit to households and firms. But he said banks can also use the cash to buy back their own bonds or buy government bonds.
Still, analysts warned that banks' appetite for the risk of additional government bonds on their balance sheets may be limited given the pressure they are under to reduce the size and riskiness of their balance sheets and build up their reserves.
Banks may instead park the excess liquidity in the ECB's overnight deposit facility or use it to help refinance debt, analysts said. Use of the ECB's deposit facility surged to €251.35 billion Tuesday from €225.55 billion Monday, as banks favored parking money with the ECB over lending it to one another because of fears around their counter-parties' exposure to weak euro-zone sovereign debt.
Analysts had expected strong demand at the three-year operation due to the possibility of early repayment after one year, as well as banks' efforts to restructure their balance sheets and the expiry of a three-month refinancing operation this week.
A sharp decline in demand for Tuesday's one-week ECB tender and a strong take-up of €141.93 billion for a one-day bridging facility, aimed at tiding banks over from the one-week to the three-year facility, further fuelled expectations of strong demand.
Demand was expected to come largely from banks in peripheral euro-zone countries, where the long-term funding market is currently very difficult. The ECB doesn't provide a break-down of the banks bidding for the funds.
The ECB's second three-year refinancing operation is due to be allotted on Feb. 29, 2012.
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