01/05/2012 11:08 am ET

Societe Generale Report: European Central Bank Lending Program Failing To Boost Liquidity

The European Central Bank's generous lending to banks is not boosting liquidity in the European economy as much as intended, according to a leading French bank. Banks are sitting on the extra cash rather than lending it out, leading to worries of a European credit crunch.

Economists at Societe Generale wrote in a report on Monday that the intended boost in the European money supply has not materialized from the ECB's lending program. As banks prefer to clean up their balance sheets rather than buy new government debt or make new loans, interest rates on government bonds are likely to remain near unsustainable high levels.

"The ECB is printing money but the transmission to the real economy is extremely weak," Societe Generale wrote. "We have been and remain skeptical that such a passive form of [quantitative easing] would reverse economic fortunes."

Stock markets around the world fell on Thursday as the euro plunged to new lows against the dollar: briefly falling below $1.28 per euro for the first time since September 2010. The CAC 40 in France fell 1.56 percent on Thursday, the FTSE Italia All-Share plummeted 3.44 percent, and the S&P 500 fell 0.65 percent as of 11 a.m.

Societe Generale pointed to one statistic -- the money multiplier -- to show that the central bank's lending program is not working. The money multiplier, which highlights the level of transmission of funds from the ECB to the general financial system, is "now at a historical low in the eurozone," Societe Generale wrote. The money multiplier has plunged from 13 at its peak in 2002 to 9 earlier in 2011 and about 6 today, according to Societe Generale.

"The pressure on banks to deleverage and the lack of appetite for non-financial private sector borrowing are such that the ECB ought to think about other plans," Societe Generale wrote.

There has been a larger than expected demand from banks for the ECB's low-interest three-year loans. The ECB has provided $628 billion, or 489 billion euros, in such loans to banks so far, according to The Wall Street Journal.

But banks are not lending that money to individuals, businesses, and other banks as much as needed. Banks have continued to break records in the amount of money that they have parked at the ECB's overnight deposit facility, hitting its latest record of $582 billion, or 453 billion euros, on Tuesday. The latest numbers show that banks deposited $569 billion, or 443 billion euros, there on Wednesday.

Societe Generale characterized these deposits as creating a self-reinforcing negative cycle: As the strongest banks leave cash at the ECB, weaker banks "cannot get funding in the market and tap the ECB heavily," it wrote in the report.

Interest rates have continued to stay elevated on long-term government debt, as banks continue to shy away from troubled government debt and focus on shoring up their balance sheets. The interest rate on 10-year Italian government debt was 7.04 percent on Thursday, and the interest rate on 10-year Spanish government debt was 5.57 percent.