ECB changes tack on Irish support, eases collateral

By Marc Jones and John O'Donnell

FRANKFURT/BRUSSELS (Reuters) - The European Central Bank threw a lifeline to Irish banks on Thursday by suspending collateral requirements for loans to them, but it stepped back from a more ambitious plan to create a new funding facility for the banks.

As Ireland released results of stress tests of the health of its banks, revealing a 24 billion euro capital shortfall among them, the ECB said it would no longer insist on minimum credit ratings for Irish sovereign debt, or for debt guaranteed by the Irish government, when accepting it as collateral in money market operations.

That will help Irish banks, which are major holders of their country's debt, continue to borrow in ECB operations if Ireland's bonds are downgraded further. Last year the ECB took a similar step to aid Greek banks.

Ireland's banks are heavily dependent on ECB funding, in the form of short-term loans of up to three months, because other euro zone banks refuse to lend to them in open markets. On top of the 85 billion euros which they borrowed from the ECB in February, Irish banks took a record 70 billion euros in emergency funding from the Irish central bank.

But while the ECB suspended collateral requirements, it did not proceed with broader plans to establish a new facility that would provide medium-term funding to Irish banks and potentially banks from other weak euro zone states in future.

This facility, by providing loans with longer tenors than ECB money market loans, might be cheaper for the banks. It would also relieve the Irish central bank of a burden by taking the place of its emergency aid.

The idea for the facility had been broadly welcomed by financial markets, where it was seen as an important tool in the euro zone's fight against the debt crises in weaker economies.

DISAGREEMENTS

A euro zone central bank source had told Reuters last week that the ECB was close to finalizing plans for the facility. But official euro zone sources said on Thursday that the ECB would not announce the plans because of internal disagreements within the central bank's Governing Council.

"There will not be a formal structure through which medium-term funding will flow either from the central bank or from one of the European funds that are now being put in place," Ireland's Finance Minister Michael Noonan said.

"But there is assurance from the European Central Bank that there will be a medium-term flow of money which underpins the restructuring and will continue into future years," he added.

The news that the ECB would not announce the new facility hit the euro slightly on Thursday, though full financial market reaction will not be clear until European markets reopen on Friday.

Ireland's central bank Governor, Patrick Honohan, suggested there was little hope of the new ECB facility being created in the near term.

"I don't see any prospect of anything imminent on the cards," he told a news conference.

Two sources with knowledge of the ECB's discussions said there had been substantial internal opposition to the plans for the new facility by some of the bank's policymakers.

"They underestimated the resistance to the idea in the Governing Council. There has been a push back...There will be another week or two of uncertainty," one of the sources said.

"This is a political negotiation with high stakes. It's a hard one for them (the ECB) to swallow," he added.

HURDLES

The ECB would have to clear a number of legal hurdles before putting such a facility in place.

There is a risk that it could be challenged in court for being at odds with the European Treaty that covers the operation of the euro zone. Since Ireland's banks are now almost completely state-owned, the facility could potentially be seen as breaking restrictions on the financing of governments.

Dutch central bank governor Nout Wellink on Thursday indicated he wanted the Irish government and perhaps other euro zone governments to do more to solve the banking problem, not the ECB.

The Irish banking sector "has become a very big black hole", he told Dutch public broadcaster NOS.

"We (Europe) will take care of the bridging facility but the Irish will have to solve it. They will have to slim down banks, slim down very strongly. They will have to close down some banks. They will have to merge some banks."

He added, "We (the ECB) are not there to finance a budget deficit nor plug holes of banks which are not solvent. Governments need to do that. Our boundaries have more or less been reached."

(Additional reporting by Gilbert Kreijger in Amsterdam, Sakari Suoninen in Frankfurt and Carmel Crimmins in Dublin; Editing by Andrew Torchia)