Some good news on the debt crisis front.

As I wrote about last month, economists have worried that the escalating eurozone sovereign debt mess could ripple east because West European banks are entrenched in post-Communist Europe, from the Czech Republic to Albania. Should some of these majors go bust as contagion undermines larger eurozone economies, post-Communist Europe could suffer a banking crisis as western sovereigns cut the umbilical to eastern subsidiaries, undermining confidence in the region’s economies.

All of Europe would take a hit in the event, according to European Bank for Reconstruction and Development Chief Economist Erik Berglof, as the fallout boomeranged back on western banks. To protect cross-border bank flows, Berglof wrote in Project Syndicate last month, European banks clearly need “massive amounts of new capital.”

Surprising markets, the European Central Bank (ECB) just announced an aggressive recapitalization scheme that, though not explicitly designed to prevent contagion in Central and Eastern Europe, will probably do just that.

“On [21 December], the European Central Bank announced that 523 banks would borrow a total of 489.2 billion euros ($640 billion),” Floyd Norris writes in The New York Times. “That was above virtually every forecast.”

“… this move will help to recapitalize European banks over time,” Norris continues, because they can use the three-year loans to buy short-term securities of their own governments for a healthy return. That’s because the banks will pay roughly 1 percent on the borrowed money, while Italian two-year securities, for instance, yield over 5 percent.

True, the banks don’t have to buy securities, but doing so could mean around 40 billion euros in “virtually risk-free” profits, Norris points out. And that’s just on the money borrowed this week – the ECB will offer more three-year loans in two months.

This is a shrewd move by Mario Draghi, the new president of the ECB. In the short-term, it buttresses both the eurozone and peripheral countries which, like much of Central and Eastern Europe, depend on its stability.

Picture of the European Central Bank in Frankfurt from Wikimedia Commons

S. Adam Cardais

S. Adam Cardais is a TOL contributing editor. Email: adam.cardais@tol.org.

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