"Providing money so cheaply, for so long, against what is now effectively any collateral whatever, leaves the ECB in a position no central bank would choose to be in," UBS AG analysts led by London-based Alastair Ryan said in a Feb. 22 note to clients. "It cannot control the credit risk coming onto its books, or at least onto the books of its national central banks. Worse, the success of its interventions risks encouraging politicians to avoid making necessary but difficult decisions."

Banks can borrow from the ECB at 1 percent and invest the proceeds in 10-year Italian government bonds yielding 5.49 percent. While that so-called carry trade will help boost banks' income, it makes them more vulnerable to a decline in the value of government debt. It also may become costlier for banks to obtain longer-term funding because ECB loans are senior to claims from other lenders.

"You are gradually putting private traders at a lower level in the capital structure and at higher risk, if things go wrong," said Alberto Gallo, head of European credit strategy at Royal Bank of Scotland Group Plc in London.

Spanish banks boosted their holdings of domestic government debt by 15 percent in December and Irish banks raised their holdings of Irish sovereign debt by 6 percent, he said. "This is a carry trade that increases banks' exposure and correlation to sovereigns," Gallo said.

Overnight Parking

Rather than heed calls by politicians to boost lending to companies and consumers, some banks are choosing to deposit the money in the ECB's overnight facility at a rate of 0.25 percent until they need it to refinance maturing debt. Deposits with the central bank rose to a record 528 billion euros on Jan. 17 and were at 477 billion euros at the end of last week, according to ECB data.

"This will ease credit flows but won't stop the great deleveraging," Huw van Steenis, an analyst at Morgan Stanley in London, wrote in a note to clients. "LTRO is important but not a panacea. While the LTRO should materially ease the euro zone deleveraging process, credit conditions appear likely to remain fairly tight in Spain, Italy and central and eastern Europe."

The 43-member Bloomberg Europe Banks and Financial Services Index rallied 17 percent after the ECB's liquidity boost. Yields on European bank debt have tumbled and the market for senior unsecured debt has reopened. Banco Bilbao Vizcaya Argentaria SA, for example, sold 2 billion euros of 18-month notes on Feb. 7 yielding 3.1 percent.

Intesa Sanpaolo SpA sold 1.5 billion euros of 18-month senior unsecured bonds last month with a yield of about 4.1 percent or 295 basis points more than the mid-swap rate. Lloyds Banking Group Plc, based in London, raised 1.5 billion euros from a five-year offering Jan. 26. It priced the bonds to yield 4.1 percent, or 305 basis points more than the benchmark swap rate.

"The crisis will only be resolved when, and if, European banks are sufficiently recapitalized to render a Greek default, and the concomitant peripheral contagion containable," Danny Gabay and Yiannis Koutelidakis, London-based economists at Fathom Consulting, said in a note to clients last week. "European politicians have been lulled into a false sense of security by the market's euphoric reaction" to the LTRO, they wrote.

Banks also are cutting lending outside their home markets, data compiled by the Bank for International Settlements show. Euro-area banks reduced lending to Asia by 9 percent and to central and Eastern Europe by 8 percent in the third quarter.

"While the two three-year LTRO tenders establish a relatively long period for the industry to adjust, the ECB exit, in our opinion, represents a large risk that will grow over the coming three years as the first quarter 2015 maturity of the three-year LTRO approaches," rating company Standard & Poor's said in a Feb. 21 note.

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