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 European Macroeconomics & Governance Tags & Topics

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.

View comments
Read article Download PDF More on this topic

External Publication

Europe after Brexit

Europe after Brexit: A proposal for a continental partnership

This paper leaves aside the issue of EU reform and focuses on the desirable EU-UK relationship after Brexit. The authors argue that none of the existing models of partnership with the EU would be suitable for the UK. They propose a new form of collaboration, a continental partnership, which is considerably less deep than EU membership but rather closer than a simple free-trade agreement

By: Jean Pisani-Ferry, Norbert Röttgen, André Sapir, Paul Tucker and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: August 29, 2016
Read about event

Upcoming Event

Sep
6-7
09:15

Bruegel Annual Meetings 2016

The Annual Meetings are a high point in Bruegel's calendar.

Speakers: Michel Barnier, Joachim Bitterlich, Arnoud Boot, Albert Bravo-Biosca, Elmar Brok, Nadia Calviño, Tom Carver, Grégory Claeys, Daniel Daianu, Zsolt Darvas, Paulina Dejmek-Hack, Maria Demertzis, Jeroen Dijsselbloem, Alicia García-Herrero, Sylvie Goulard, Charles Grant, Dominique Guellec, Connie Hedegaard, Michel Houdebine, Vazil Hudák, Brigitte Knopf, Pascal Lamy, Lawrence J. Lau, Matthew Lobner, Robert Madelin, Sylvie Matherat, Simone Mori, Erik F. Nielsen, Barbara Novick, Jean Pisani-Ferry, Romano Prodi, Olli Rehn, Carmen M. Reinhart, André Sapir, Dirk Schoenmaker, Ludger Schuknecht, Egon Schulz, Maroš Šefčovič, Jeremy Shapiro, Scott Stern, Jean-Claude Trichet, Laszlo Varro, Nicolas Véron, Reinhilde Veugelers, Helen Wallace, Guntram B. Wolff and Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Autoworld, Brussels, Belgium
Read about event More on this topic

Upcoming Event

Sep
14
10:00

From crisis management to launching economic growth

What have been the most effective strategies in limiting the impact of the economic crisis in Europe? What challenges lie ahead? Bruegel's 10th anniversary event in Budapest will foster discussion of these important topics.

Topic: European Macroeconomics & Governance Location: Budapest, Hungary
Read about event More on this topic

Upcoming Event

Sep
29
08:30

Inclusive growth in the European Union

Why is inclusive growth important and how do the EU’s social problems differ from social problems in other parts of the world?

Speakers: Zsolt Darvas, Monica Brezzi, Jana Hainsworth, Reinhilde Veugelers and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

IMG_1985

How to make the single market more inclusive after Brexit

The creation of the single market generated winners and losers. Yet redistribution remains first and foremost a competence of national governments. It is thus fair to state that a failure in national, more than European, policies and welfare systems can be partly blamed for current discontent with the EU and the single market.

By: Alessio Terzi Topic: European Macroeconomics & Governance Date: August 18, 2016
Read about event More on this topic

Upcoming Event

Oct
4
12:30

Barriers to long-term investment

Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The state of macro redux

What’s at stake: In 2008, Olivier Blanchard argued in a paper called “the state of macro” that a largely shared vision of fluctuations and of methodology had emerged. With the financial crisis and our inability to prevent the greatest recession since the 1930s, the discipline entered into a period of soul searching. The discussions on the state of macro received new echoes this week after Blanchard published a short essay on the future of DSGE models.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: August 16, 2016
Read article More on this topic More by this author

Opinion

Dalia Marin

What’s the matter with Austria?

Austrian firms invested heavily in Central and Eastern Europe. They offshored the parts of the value chain that required specialized skills and produced valuable research. This resulted in lowered growth in Austria.

By: Dalia Marin Topic: European Macroeconomics & Governance Date: August 9, 2016
Read about event More on this topic

Upcoming Event

Nov
21-22
13:30

Vision Europe Summit 2016

The 2016 Vision Europe Summit is titled "Redesigning European Migration and Refugee Policy" and will be held in Lisbon on 21-22 November 2016.

Topic: European Macroeconomics & Governance Location: Lisbon
Read article More on this topic More by this author

Blog Post

André Sapir

Should the UK pull out of the EU customs union?

The UK Government appears divided on whether the United Kingdom should seek to remain within the European Union’s customs union after Brexit. The United Kingdom is likely to want to leave the customs union, even it remains in the EU’s single market. But the UK should try and keep to the EU’s commitments at the WTO, at least at the start, in order to minimise the trade disruption that Brexit entails.

By: André Sapir Topic: European Macroeconomics & Governance Date: August 1, 2016
Read article More on this topic

Opinion

Grégory Claeys
Schoenmaker pic

Now is the time to open Strasbourg’s ‘Bronislaw Geremek’ European University

It is the right time to revive the proposal made 10 years ago by Bronislaw Geremek and Jean-Didier Vincent to create a truly European University in the European Parliament buildings in Strasbourg.

By: Grégory Claeys and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: August 1, 2016
Read article More by this author

Blog Post

Zsolt Darvas

Single market access from outside the EU: three key prerequisites

In relative terms, Norway’s current net financial contribution to the EU is similar to the UK’s. Switzerland and Liechtenstein pay surprisingly little, while Iceland is a net beneficiary. Relative to their population, Switzerland, Norway, Iceland and Liechtenstein received about twice as large an inflow of EU immigrants as the UK. These countries also have to adopt the vast majority of EU regulation to gain access to the single market.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: July 19, 2016
Load more posts