The Associated Press June 5, 2012, 12:31PM ET

Key ECB steps to combat Europe's debt crisis

Here are some of the key steps the European Central Bank has taken to try to stem Europe's crisis over too much debt in some countries.

CHEAP LOANS TO BANKS: The ECB announced late last year that it would make unlimited loans for a record three years available to the 7,500 banks in the eurozone. On Dec 21, 523 banks took up the bank on its offer, grabbing (EURO)489 billion ($608.17 billion) in loans, followed by (EURO)530 billion to 800 banks on Feb. 28. The (EURO)1 trillion flood of cash has relieved the strain on banks whose finances were so troubled that they could not borrow from other banks.

The ECB made the loans in its capacity as emergency lender of last resort that banks can turn to if no one else will lend to them. It's forbidden by the EU treaty from playing the same role for governments, however.

The long period of the loans gave banks security that they would have the money they needed until 2015, and helped ease the crisis.

Crucially, some banks took the cheap money and started buying higher-yielding government bonds with it. That raised bond prices and lowered bond interest rates, which move in opposite direction from the price. The lower interest yields meant lower borrowing costs for struggling Spain and Italy.

That relief has proved short-lived, however, as those two countries are now seeing borrowing costs rise again.

The bank has resisted calls to do a third round of loans. In part that is because banks have plenty of cash, yet are not finding the demand for loans from businesses. This is due to a weak economy that gives business owners little reason to think they should borrow to expand their businesses.

LOWER INTEREST RATES: Under new President Mario Draghi, the ECB cut interest rates in November and in December by a quarter percentage point each time, to a record low of 1.0 percent. With inflation at 2.4 percent, that means short-term interest rates are so low they are negative in inflation-adjusted terms. The bank's benchmark refinance rate sets the cost of the credit it offers to the eurozone's banks. The rate also strongly influences other interest rates, doing much to set the cost of credit for businesses, banks and consumers.

RESERVE CUT: The bank cut the required amount that banks must keep on reserve with it, from 2 percent of their assets to 1 percent. That immediately freed some (EURO)100 billion for the banks to use elsewhere.

BOND PURCHASES: The bank bought over (EURO)200 billion in government bonds on the secondary market -- meaning from other investors. It's prohibited from buying them directly from governments, which would mean loaning that government money at the expense of the other eurozone countries. The program pushed up bond prices and reduced their yields, helping calm the debt crisis for a while. But it skirted the rules in the EU treaty against financing government and was therefore carried out on a small scale. That meant it did not impress bond markets as much as it could have. The ECB has paused the program and there's no indication of when, or whether, it will start again.


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