Fitch Ratings says in a report that European Central Bank (ECB) lending is continuing to facilitate liquidity in financial markets as intended, rather than providing structural funding for European banks' core businesses. The agency's findings run counter to some media reports and views that European banks are increasingly using ECB lending facilities to meet core funding needs.

"We believe that none of the national banking systems in the euro zone are dependent on ECB liquidity to finance their day-to-day operations," says Julia Peach, Managing Director and head of Fitch's European Financial Institutions group. "The ECB's actions are reducing systemic banking risk, which in turn leads to greater stability for bank ratings. Nevertheless, ongoing reliance on such sources of liquidity is unsustainable and could create dislocation of funding sources for some banks, should the crisis be prolonged."

ECB lending is funding approximately 1.6% of total banking system assets as of end-March 2008, compared with 1.4% in January 2000. There has been no material change in the proportion of banking system assets funded by the ECB since the early days of the Eurosystem. There is, however, a concern that the extra funding with lengthening maturities made available by the ECB may bring some unintended risks to the recovery of the wholesale markets.

"ECB eligibility criteria has left the door open for some banks to structure riskier transactions, both in terms of lower credit enhancement and riskier collateral profiles than were seen when structured finance markets remained open prior to summer 2007," says Stuart Jennings, Managing Director and Structured Finance Credit Officer at Fitch. "There is a risk that banks will retain liquid collateral, which can be pledged with other counterparties, while using more illiquid structured assets and riskier collateral in ECB repo transactions."

Fitch also notes that Spanish and Dutch banks had become increasingly dependent on the covered bond and securitisation markets in recent years and were more affected when the structured market dried up. However, while banks in these countries have increased borrowing from the ECB, their shares of central bank lending have remained broadly in line with each country's share of total banking system assets. French and Italian banks have hardly increased their use of central bank lending facilities since August 2007, relative to total banking system assets, due to their broad and stable retail deposit base.

The agency also believes a number of non euro-zone banks, most notably UK banks, have made use of ECB liquidity facilities via their European operations, or through intermediaries in return for a fee or margin. The agency believes this has been a positive development for stability of bank ratings in these countries, helping to relieve liquidity pressures felt by those banks whose own central banks may have more restrictive collateral requirements.