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European Central Bank loans $639 billion to banks. Will it help?

European Central Bank loans are intended to keep banks lending and avoid a credit crunch. But the head of the European Central Bank resists providing similar help to indebted nations.

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Markets initially rose modestly on the outsized amount of credit support, which was far higher than the €300 billion ($392 billion) expected, but the advance soon faded as the loans highlighted the problems facing Europe's banks. The Stoxx 50 of leading European shares was down 0.5 percent while the euro was trading 0.6 percent lower at $1.3038.

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"The good news is, the ECB's efforts to increase liquidity are working," said Jennifer Lee, an analyst at BMO Capital Markets. "The bad news is, high demand for the loans creates worries that banks are urgently in need of funds to boost liquidity."

Italy and Spain have been at the center of investor concerns in recent months as their borrowing costs have risen amid concerns over their debts. Both are considered too big to bail out with the current eurozone bailout funds, which have some €500 billion ($654 billion) in financing.

A default on debt payments by either could ignite a new financial crisis and send the global economy into a slump.

Some of that European rescue money is already committed to bailouts of smaller Greece, Ireland and Portugal, which needed outside financial help after default fears drove their borrowing costs to unsustainable levels.

Italy alone has some €1.9 trillion ($2.5 trillion) in outstanding debt.

In making the loans, the ECB was playing its role of supplier of liquidity to banks, a typical job for central banks.

ECB president Mario Draghi has stressed the central bank's role in supporting the banking system but has balked at suggestions it should be offering the same level of support for indebted governments themselves by buying up their risky bonds. Draghi says governments must be the ones to reduce their spending and deficits and should not depend on a central bank bailout.

There was some speculation that the loans could help governments, since banks could borrow money cheap from the ECB and use the money to buy higher-yielding European government bonds.

But many analysts think it was unlikely that banks would increase their exposure to government bonds, given ongoing fears of a possible default among troubled eurozone nations. Many banks have struggled to cut their holdings of debt from governments in financial trouble.

"We still believe it is difficult to reconcile a government desire for banks to continue buying debt with the need for banks to reduce risk exposure associated with government debt," said Chris Walker, an analyst at UBS.

The 37-month term of the loans permits the banks to stock up on money for a much longer period and reduces stress on their finances. Draghi has said the extra-long credit period will allow banks to lend for longer periods and not cut credit to businesses.

Alongside efforts to shore up banks, the European Central Bank has also been cutting interest rates to support the ailing eurozone economy. It has reduced its main refinancing rate from 1.5 percent to 1.0 percent over the last two months in the hope that lower borrowing costs will stimulate growth by making credit cheaper.

Under the terms of Wednesday's loans, the banks will pay the average refinancing rate over the three years. The ECB reviews the rate each month and it will almost certainly change. Banks also have the flexibility of repaying the money after a year if their situation improves.

European officials have said banks need to raise €115 billion ($150 billion) in new capital in 2012 — but finding that money is not an easy task in the current environment of fear. Investors are leery of putting more money into banks and it would be politically unpopular for debt-strapped governments to do it either.