Exclusive: ECB mulls ultra-long loans to help banks

BRUSSELS (Reuters) - The European Central Bank is looking at extending the term of loans it offers banks to 2 or even 3 years to try to prevent the euro zone crisis precipitating a credit crunch that chokes the bloc's economy, people familiar with the matter say.

The ECB is examining this unprecedented possibility as intensifying fears about the euro zone succumbing to its debt crisis hurt the interbank money market, with banks scaling down the list of peers to which they are ready to lend.

The central bank is looking into offering banks liquidity over a 2-year or even 3-year horizon, the sources said, aiming to free up the increasingly blocked interbank money market and give banks more leeway to buy and hold sovereign bonds.

To date, the longest term it has offered funds is one year.

As the sovereign debt crisis has worsened, the ECB has been coming under increasing pressure to intervene on a larger scale by buying state bonds but is reluctant to make such a commitment.

It does, however, have the freedom to lend banks trillions of euros and could use this firepower to indirectly support governments trying to issue debt.

The ECB has flagged the possibility of longer-term loans to banks, sources familiar with the matter told Reuters, in a move that could be aimed at gauging their interest ahead of a launch.

The possibility of lending over a longer time horizon was raised at a meeting last week between the ECB and a group of banks including Goldman Sachs, Barclays Capital and Morgan Stanley, according to one person familiar with the matter.

"What was said was that they would be prepared to offer two or three years LTRO (lending operations)," that person said.

"The question (for the ECB) is whether banks would be interested in it. It could be seen as a stigma if a bank was using 2 or 3-year financing with the ECB. It might not get enough take-up to make a difference."

Another source said the ECB was looking at the possibility of providing liquidity over a similar time horizon but by giving a series of shorter-term loans with the pledge to keep this line of credit open for up to three years.

A third official familiar with the matter said: "It's being discussed ... But there is no decision yet."

The ECB first introduced extra-long 12-month liquidity tenders in June 2009. Last month, it rewewed offers to lend banks one-year funding in two operations this year -- a 12-month longer-term refinancing operation (LTRO) in October and a 13-month operation in December.

There has, however, only been lukewarm interest, suggesting that more ECB cash may not be the answer to a creeping credit freeze.

Interbank markets remain tight, with banks worried about the health of their peers and also holding back cash as they face the prospect of having to set aside funds to cover potential losses on their sovereign debt holdings. International demands that they raise their capital base have exacerbated the problem.

This nervousness was highlighted on Tuesday when euro zone banks' demand for ECB funding surged to a two-year high, as fast spreading sovereign debt worries left lending markets virtually frozen and the ECB as the only source of funding for many institutions.

ECB Governing Council member Luc Coene said earlier this week regulators must ensure banks take account of the riskiness of government bonds they own, adding to pressure on banks to set aside more capital to cover such losses.

By offering banks liquidity for an ultra-long period of two or three years, the ECB could help to reinforce confidence in banks and also do the same for rocky sovereign debt markets.

"To the extent that you are improving the situation for banks, you are improving the situation for a major potential purchaser for sovereign debt," said one banker. "They will know that they can refinance with the bank (ECB)."

One senior executive from a European bank, speaking anonymously, said he favored an extension of the terms under which the ECB lends to banks.

"Now, it's 13 months and if we could go to 24 months, that would be better. Thirty six months would be better still but then we are at the point of medium-term financing."

(Editing by Mike Peacock)