ECB looks to banks to deliver QE on its behalf

FRANKFURT/PARIS, July 9 (Reuters): The European Central Bank (ECB) is hoping a new round of long-term loans will be used by banks to drive down borrowing costs - a substitute for an asset-purchase scheme of its own which would avert a potentially damaging internal split.

The ECB unveiled the loans plan last month as part of a package of measures to breathe life into a sluggish eurozone economy, where inflation is running far below the central bank's target and there is a dearth of credit to smaller firms.

Presented as a means to foster bank lending to businesses, the scheme is in fact a hybrid programme that also offers banks access to cheap funding for four years with which they can buy financial assets.

Policymakers hope that in the round it will create a "credit multiplier" effect, tantamount to enabling the private sector to embark on quantitative easing (QE) - creating money to buy assets to keep borrowing costs low and boost spending - on the ECB's behalf.

"It's loans but not only loans," ECB Executive Board member Peter Praet said of the funding programme.

"It's also the liquidity injection, the funding substitution," he told the news agency in Paris on Wednesday.

The idea is that one or more of three things will happen:

Banks will use the money to lend to households and businesses, thereby directly helping to revive the economy; they take the money and buy assets themselves; they use the funds to substitute for issuing their own debt.

The latter two could lower the funding costs for all banks, even those who don't take the ECB's money, and spill over into looser conditions in the broader corporate credit market, hopefully making money cheaper and easier to access.