Blog Post

T-(rompe-l’Oeil)-LTRO

I already pointed out that several important points were quite vague in the initial ECB T-LTRO announcement. Some of these have been clarified, but the most important issue is still unaddressed - how (if at all) will banks be prevented from using the funds to buy government bonds?

By: Date: July 4, 2014

Yesterday the ECB’s Governing Council unveiled further technical details on its new programme of Targeted Long-Term Refinancing Operations (TLTRO). This was announced on the 5th of June and at present it constitutes the main hope for the ECB to be able to fight the risk of deflation in the euro area, given that no asset purchase programme has yet been announced. I already pointed out that several important points were quite vague in the initial ECB announcement. Some of these have been clarified, but the most important issue is still unaddressed – how (if at all) will banks be prevented from using the funds to buy government bonds?

The first clarification concerns the criteria behind the allocation of funds. As a reminder from my previous piece, the TLTRO will work in two phases. Under the first phase, banks will be able to borrow up to an initial allowance, in two operations in September and December 2014. The Initial allowance is defined as 7% of the outstanding amounts of loans to euro area non-financial corporations and households, excluding loans to households for house purchase, as of 30 April 2014.

This was known since the beginning, but it is interesting to learn that banks will be given the possibility to participate to the TLTRO as standalone borrowers or in “TLTRO groups”, provided they can qualify as sufficiently “closely linked”. This can potentially leverage the effectiveness of the TLTRO. The borrowing limits applicable to the leading institution of a TLTRO group will be calculated on the basis of the outstanding amounts of eligible loans and eligible net lending granted by all members of the TLTRO group in aggregate. The funds will then be presumably spread out across the members of the group, so that some members could benefit from a larger amount of funds than they could get if they were participating as standalone borrowers.

More interesting are the criteria that will apply for the second phase of the TLTRO, the one that should allows “leveraging” the measure beyond the initial allowances and at the same time imposing the incentive for banks to actually use the funds for lending to the economy. Between March 2015 and June 2016, banks will in fact be able to borrow additional amounts that can cumulatively reach up to three times each bank’s net lending provided between 30 April 2014 and the respective allotment reference date, in excess of a specified benchmark. It goes without saying that the definition of the benchmark is crucial for the success of the programme.

The  ECB has specified yesterday how the benchmark will be computed, and as anticipated, it looks rather generous. In particular, the benchmark will differ depending on the net lending position of banks. For banks that had positive or zero eligible net lending in the 12-month period up to 30 April 2014, the benchmark will be set at zero eligible net lending (see Chart 1). This basically means that in order to qualify for the 6 TLTROs conducted from 2015 on, banks will just need not to shrink their balance sheet and perhaps do a little bit better than they did over last year, depending on how much they wish to leverage in the second phase (the bigger their net lending from now on, and the larger the amount they will be able to borrow under the second wave of TLTROs).

For banks that instead had negative eligible net lending over last year, the benchmark will be a function of the average monthly eligible net lending achieved in the twelve months to 30 April 2014 (so a negative bechmark) until June 2015, then it will be set to zero as for the other banks.

Source: ECB

In practice, this is nothing but a complicated way to say that it should be rather easy for banks to qualify for the funds. “Virtuous” banks, who were already increasing their lending to the economy over last year will be required basically not to shrink their balance sheet or do a little better than they were doing. Banks that were instead contracting their balance sheet will be allowed some more time before having to turn to positive net lending. Over that period they will be just required to deleverage at a slower pace than they were doing until now, but they will be able to borrow.

Up to here, positive news that should favour a big take up of the TLTRO – Draghi proved optimist in the press conference, anticipating that banks could decide to borrow in the order of 1trn. However, one point remains apparently unaddressed and it is a crucial one. The ECB in fact has not added clarity about how (if at all) banks will be prevented from using the funds to buy government bonds. Banks could use part of the funds borrowed in Phase 1 to buy government bonds and still qualify for Phase  2, but even in case they were not to qualify the only consequence at the moment appears to be that they would be forced to repay the funds earlier but could still enjoy the profits of a carry trade in the meantime. More generally, there seems to be no specific constraints once the funds are borrowed and, as noted by several analysts, there seems to be no penalties in view for the banks that do not meet the benchmarks. This is definitely not a second order issue, as it could be appreciated over the last 2 and ½ years, and it constitutes an important flaw of the previous LTRO operations.

Until there is a clear solution to the issue of monitoring the use of funds, the additional “T” is just a Trompe-l’œil.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Topics

Comments

Read about event More on this topic

Past Event

Past Event

Fighting corruption: from headlines to real impact

Despite recent efforts to tackle corruption there is not much evidence that these strategies are producing results. Why is this the case and what can we do to improve the situation?

Speakers: Carl Dolan, Mihaly Fazekas, Alina Mungiu-Pippidi and Alessio Terzi Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 28, 2016
Read about event More on this topic

Past Event

Past Event

Active labour market policies, what works?

How are Europe's labour markets performing, and what policies can best help them function?

Speakers: Alfonso Arpaia, Clyde Caruana, Grégory Claeys, Dan Finn, Regina Konle-Seidl, Alfred Mifsud, Godwin Mifsud, Edward Scicluna and Paul Swaim Topic: European Macroeconomics & Governance Location: Mediterranean Conference Centre Triq l-Isptar, Valletta, Malta Date: April 27, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Understanding HM Treasury’s Brexit analysis

What’s at stake: The UK will hold a referendum on its membership of the EU on June 23rd 2016. Her Majesty’s Treasury released an assessment of the impact of Brexit finding that the economy would be between 3 and 7% smaller in 2030 if the UK left the EU than it would be if it stayed in.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: April 25, 2016
Read article More on this topic More by this author

Blog Post

jaume

Are regional governments causing deficit overshooting in Spain?

Spain once again missed its deficit target in 2015 and it seems unlikely that 2016 will be any better. The central government has pointed to regional deficits as being the cause of the fiscal slippage. However, regional governments claim that their deficit is due to under-financing and overly strict deficit targets.

By: Jaume Martí Romero Topic: European Macroeconomics & Governance Date: April 19, 2016
Read about event More on this topic

Past Event

Past Event

CANCELLED: The Search for Europe

This event has been cancelled because of an unforeseen change in the calendar of the main speaker.

Speakers: Francisco González, Sylvie Goulard, Veronica Nilsson, John Peet, Javier Solana and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 19, 2016
Read about event More on this topic

Upcoming Event

25 
May
2016
12:30

Lessons for the euro from early US monetary and financial history

The United States has a monetary union that many look to when considering the future of the EU. But how easy was it really to create such a union and what can Europe learn from the US process?

Speakers: Jeffry Frieden and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic

Blog Post

IMG_20151009_103117 (3)
Karen E. Wilson
Guntram B. Wolff

Youth unemployment in the Mediterranean region and its long-term implications

Youth unemployment in the Mediterranean region has consequences for the whole of Europe. Tackling youth unemployment in the region must continue to be a high policy priority.

By: Nuria Boot, Karen E. Wilson and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: April 13, 2016
Read article More on this topic

Opinion

Grégory Claeys
Zsolt Darvas

How to reform EU fiscal rules

The current inefficient European fiscal framework should be replaced with a system based on rules that are more conducive to the two objectives of public debt sustainability and fiscal stabilisation.

By: Grégory Claeys and Zsolt Darvas Topic: European Macroeconomics & Governance Date: April 12, 2016
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

Making the EU-Turkey refugee deal work

The EU deal with Turkey reached on 18 March is problematic, but without a deal the EU’s external borders would have collapsed completely. Now the EU needs to support Greece and increase the number of refugees taken directly from Turkey.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: April 11, 2016
Read article More on this topic

Opinion

fratzscher-03
Reint_Gropp_m
p2-Kotz
jan-pieter-krahnen
odendahl-june14-1409577172
Beatrice Weder di Mauro
Guntram B. Wolff

Mere criticism of the ECB is no solution

What would happen if the ECB failed to respond to the excessively low inflation and the weak economy? And what economic policy would be suitable under the current circumstances, if not monetary policy?

By: Marcel Fratzscher, Reint Gropp, Hans-Helmut Kotz, Jan Krahnen, Christian Odendahl, Beatrice Weder di Mauro and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: April 10, 2016
Read article More on this topic More by this author

Blog Post

Zsolt Darvas

The structural budget balance limbo

A key indicator in the EU’s fiscal framework is the structural budget balance, but estimates of the indicator by the European Commission, IMF and OECD are revised a lot from one year to the next, sparking concerns among some EU finance ministers.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: April 7, 2016
Read article More on this topic

Opinion

Agnès Bénassy-Quéré
Guntram B. Wolff

ECB decisions put lack of fiscal union in the spotlight

Fiscal policy in the euro area is hardly supporting the recovery and the ECB. The EU needs a a proper fiscal union in order to stabilise the economy and inflation. We see four main avenues for achieving a viable fiscal framework.

By: Agnès Bénassy-Quéré and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: March 30, 2016
Load more posts