European Central Bank could boost emergency credit offerings this week to strengthen banking system pressured by European debt crisis

Cindy Allen

FRANKFURT, Germany , October 4, 2011 (Associated Press) – The European Central Bank could boost emergency credit offerings on Thursday to help shore up a banking system that has come under increasing pressure from the eurozone debt crisis.

Economists say the meeting in Berlin is much less likely to result in a cut in the bank's benchmark refinancing rate from the current 1.5 percent, though it is not completely ruled out.

The eurozone's troubled banks will be a major topic at the meeting and at the subsequent news conference, the last such appearance for bank President Jean-Claude Trichet before his eight-year term expires Oct. 31 and he hands over to successor Mario Draghi.

Many economists expect the bank will open its credit window wide, as it did during the financial crisis that followed the 2008 collapse of U.S. investment bank Lehman Brothers. Analysts say the central bank could decide to offer unlimited credit for six months or a full year, and could also buy asset-backed securities known as covered bonds from banks.

That would provide support to European banks that are having difficulty borrowing normally from other banks. Banks are reluctant to lend because they fear Greece could default on its government bonds and cause losses that mean other banks would not pay them back.

The European Central Bank already offers short term credit for as long as 3 months, but extending the loan period means banks are less vulnerable to market turmoil.

Protecting banks would be a key challenge if financially troubled Greece defaults on its debts, either in a coordinated way with eurozone governments' approval or a disorderly default in which the country simply runs out of money.

Belgium's finance minister, Didier Reynders, said Tuesday that the eurozone will likely boost the financial firepower of its euro440 billion ($580 billion) rescue fund. One of the fund's purposes is to help recapitalize troubled banks, but as the eurozone's debt crisis has intensified the fund has started to look too small to reassure markets.

Eurozone officials however have moved slowly to beef up the rescue fund and to get Greece an additional installment of money from a 2010 bailout that could keep it from a disorderly default in coming weeks.

That puts additional pressure on the ECB as eurozone crisis manager.

"The ECB will once again face a role as fire brigade in the debt crisis," economist Carsten Brzeski at ING in Brussels wrote in a research note. "While the ECB looks likely to get the remaining tools out of the 2008 first aid kit on Thursday, a rate cut could be a bridge too far, for the time being."

Royal Bank of Scotland however predicts a quarter point cut Thursday, and if not then, by the Nov. 3 meeting. More economists think the bank will lower rates to 1.0 percent by early next year.

Signs that Europe's economy is headed for a slowdown or recession are increasing pressure on the bank to cut rates. But September's sharply higher inflation rate of 3.0 percent means the bank's 23-member rate-setting council may wait.

A rate cut could help keep the economy from slowing because it lowers borrowing costs for businesses. But lower rates can also fuel inflation.

Signs of trouble among banks have multiplied in recent days. The Franco-Belgian bank Dexia saw its shares fall 24 percent Tuesday in the wake of a statement by Moody's that the agency might downgrade its credit rating. Dexia is heavily exposed to Greek debt.

Deutsche Bank said it couldn't achieve its profit estimate for the year and would write down an additional euro250 million ($333 million) in Greek debt after taking a euro155 million ($207 million) Greek debt charge in the second quarter.

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