European Bank Stocks Rally – Why not?

I saw this article in the Financial Times and I had to comment.  There was a big rally in European Bank stocks in January.

Why shouldn’t European Banks rally?  They are getting practically free money in the form of low interest loans from the European Central Bank as part of an unlimited three year loan program announced in December known as Long-Term Refinancing Operations or LTRO’s.

As I commented on in a recent post, even the Royal Bank of Scotland (remember the UK is not part of the Eurozone single currency) was able to take advantage of the new ECB funding mechanism through it’s subsidiary in The Netherlands.

You remember the basics of how banks make money.  They take in deposits for which they pay the depositor a usually fixed interest rate.  These are considered liabilities by the bank.  Then they take that money and loan it out to a borrower at a higher interest rate.  These loans are considered assets by the bank.  Pretty simple.

The question is: will they loan the money out?  Some people think the banks will hoard the extra liquidity that these funds provide.  Others think they might buy bonds of distressed countries to make a quick buck.  In any case, these bank stocks look better in January than they did in December.  Great, but let’s hope these funds fulfill their intended purpose and that is to stabilize the Eurozone.