The number of financial institutions flocking to the EuropeanCentral Bank's three-year loans soared to 800 and borrowing rose toa record in an operation that may boost the euro-area economy.

The Frankfurt-based ECB said it will lend banks 529.5 billioneuros ($712.2 billion) for 1,092 days, topping the 489 billioneuros handed out to 523 institutions in the first three-yearoperation in December. Economists predicted an allotment of 470billion euros in today's tender, according to the median of 28estimates in a Bloomberg News survey.

“The astonishing number this time is the number of banksparticipating, which signals that a lot more small banks looked forthe money and it is likely they will pass it on to the economy,”said Laurent Fransolet, head of fixed income strategy at BarclaysCapital in London. “So the impact may be bigger than with the firstone.”

Bond and equity markets have rallied since the ECB's firstthree-year loan, suggesting banks are investing at least some ofthe money in higher yielding assets. That's helped ease concernabout a credit crunch and won governments time to agree on measuresto contain the sovereign debt crisis. The risk is that banks becometoo reliant on ECB money and fail to take the steps needed tostrengthen their balance sheets.

The euro fell after the ECB announcement to $1.3452 at 1:45 p.m.in Frankfurt from $1.3471 beforehand. Italian and Spanish bondsrose on bets the ECB loans will be used to buy the nations' debt.The yield on Italy's two-year note fell 21 basis points to 2.15percent.

European bank stocks rose, with the 43-member Bloomberg EuropeBanks and Financial Services Index up 1.3 percent at 12:48 a.m. inLondon. Bank of Ireland, Italy's UniCredit SpA and France's CreditAgricole SA were among the biggest gainers. The Stoxx Europe 600Index increased 0.4 percent.

Today's loans are the biggest single refinancing operation inthe ECB's history and take total three-year lending above 1trillion euros. The ECB lends banks as much as they want againsteligible collateral. More than a third of the 2,267 financialinstitutions registered to borrow from the ECB took part.

“Clearly there is no sign of stigma here,” said Michel Martinez,an economist at Societe Generale in Paris.

Too Good to Refuse

Banks that shunned the first loans for reputationalconsiderations may have concluded “it was an offer they couldn'trefuse after all,” said Martin van Vliet, an economist at ING Groupin Amsterdam. The ECB's move to encourage take-up by increasing thepool of collateral banks can use to obtain the funds also appearsto have worked, he said.

Before the December operation, the ECB reduced the ratingthreshold for certain asset-backed securities. This month, it saidseven of the 17 national central banks in the euro area will alsoaccept credit claims, which ECB President Mario Draghi estimatedwould increase the collateral pool by another 200 billion euros.The aim is to give small and medium-sized banks greater access toECB cash.

Economists at Barclays Capital, ING Group and Royal Bank ofScotland Group Plc estimate about 230 billion euros of today'slending is accounted for by existing ECB loans being rolled intothe new facility, meaning about 300 billion euros is new cash. Thatexceeds the estimated 193 billion euros of fresh lending in thefirst three-year tender.

The funds cost the average of the ECB's benchmark interest rate— currently at a record-low 1 percent — over the period of theloans and banks have the option of repaying them after a year.

The euro-area economy is forecast by the European Commission tocontract 0.3 percent this year as the debt crisis promptsgovernments and consumers to cut spending. The ECB's loans areintended to relieve liquidity strains and grease the flow of creditto households and businesses, boosting growth.

“There's a big difference between stopping the rot and startinga recovery,” said Steve Barrow, head of Group-of-10 research atStandard Bank Plc in London. The loans “might have done the first,but they won't do the second,” he said.

Royal Bank of Scotland economist Nick Matthews said while theECB's liquidity provision “helps keep tail risks for European banksat bay in the near term,” the loans “do not address the underlyingsolvency issues, and ultimately funding stresses can quicklyreturn.”

Sarkozy Trade

A byproduct of the loans has been the so-called “Sarkozy trade,”where yield-hunting banks use some of the cash to buy sovereignbonds — an idea first floated by French President NicolasSarkozy.

Since the first three-year loans were awarded on Dec. 21, theyield on Spanish two-year bonds has fallen to 2.28 percent from 3.6percent and the Italian equivalent has dropped from 5 percent. TheEuro Stoxx 50 Index of stocks is up 9 percent this year.

No further three-year operations are scheduled and ECB officialshave indicated they would be reluctant to offer a thirdtranche.

“If number one was a success and number two was a success, thatdoesn't mean there has to be number three,” ECB council memberEwald Nowotny said on Feb. 27.

In the wake of the first operation, the ECB's balance sheetballooned to a record 2.74 trillion euros. That prompted Germancouncil member Jens Weidmann to warn that the central bank mustn't“lose sight of its mandate” to control inflation by taking on“excessive risks.”

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