ECB Balance Sheet Jumps to Record 3 Trillion Euros on Ban

The European Central Bank’s balance sheet surged to a record 3.02 trillion euros ($3.96 trillion) last week, 31 percent bigger than the German economy, after a second tranche of three-year loans.

Lending to euro-area banks jumped 310.7 billion euros to 1.13 trillion euros in the week ended March 2, the Frankfurt-based ECB said in a statement today. The balance sheet gained 330.6 billion euros in the week. It is now more than a third bigger than the U.S. Federal Reserve’s $2.9 trillion and eclipses the 2.3 trillion-euro gross domestic product of Germany, the world’s fourth largest economy.

The ECB last week awarded banks 529.5 billion euros for three years in the biggest single refinancing operation in its history, adding to the 489 billion euros it lent in December. The flood of money, which aims to combat Europe’s sovereign debt crisis by unlocking credit for companies and households, has increased the risk exposure of the 17 euro-area central banks that together with the ECB comprise the Eurosystem.

“With the dramatic expansion of its balance sheet since last summer, the ECB has become the most active central bank in the world,” said Klaus Baader, chief euro-area economist at Societe Generale in London. “The ECB’s measures are absolutely justified, but it has to be aware of the risks on its balance sheet and think of an exit strategy.”

The euro extended its drop and traded at $1.3121 at 3:25 p.m. in Frankfurt. European stocks fell, taking the decline on the Stoxx Europe 600 Index to 2 percent today.

‘Substantial Risks’

The balance sheet has swelled by more than 1 trillion euros since mid July as the debt crisis made banks wary of lending to each other, forcing the ECB to provide additional liquidity and step into bond markets with its asset-purchase program.

The balance sheet records all the assets and liabilities on the books of the ECB and the central banks of the euro area, which conduct market operations on the ECB’s behalf.

ECB council member Jens Weidmann, who heads Germany’s Bundesbank, said the unprecedented three-year loans are “at the limits” of the central bank’s mandate and warned of “substantial risks,” Spiegel magazine reported on March 3.

Collateral Rules

The ECB has loosened rules on the collateral it accepts against loans, increasing the risk that taxpayers would have to foot the bill if a bank defaults. The lending could also discourage banks and governments from implementing reforms, or even fuel inflation.

Bond and equity markets have rallied since the ECB’s first three-year loan in December, suggesting banks are investing at least some of the money in higher yielding assets. That’s helped ease concern about a credit crunch and won governments time to agree on measures to contain the debt crisis.

European leaders on March 2 signed a German-inspired deficit-control treaty to increase fiscal discipline. With a second Greek aid package wrapped up and the euro region slipping into recession, the leaders also committed to a pro-growth agenda. The euro-area economy will contract 0.3 percent this year, according to the European Commission.

“Central bank liquidity buys politicians time,” said Stephen Gallo, head of market analysis at Schneider Foreign Exchange in London. If they fail to use it wisely, “history will likely judge the damage done by central bank liquidity injected today as irreparable,” he said.

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