Blog Post

ECB TLTRO 2.0 – Lending at negative rates

On Thursday, the ECB surprised observers by announcing a new series of four targeted longer-term refinancing operations (TLTRO II) to be started in June 2016. The incentive structure of the programme has changed: on one hand, this TLTRO II could be the first case of lending at negative rates; on the other hand, the link with lending to the real economy might have been weakened.

By: Date: March 11, 2016 Topic: European Macroeconomics & Governance

You can read this post in German on Makronom.

Makronom

The ECB first announced its targeted long-term refinancing operations (TLTRO)  in summer 2014, and operations started in September 2014. Under the first version of the programme, banks could borrow an initial allowance of 7% of their outstanding loans to the euro area non-financial private sector. They could then borrow additional funds in a second wave in March 2015 and June 2016, depending on their net lending to the real economy.

ECB President Mario Draghi said on March 10 that the TLTRO has been successful. In terms of total outstanding ECB liquidity (figure 1), TLTROs have substituted for part of the liquidity drained by the redemptions of 3-year LTROs, keeping the total liquidity allocated through refinancing operations above 500 billion euros.

Figure 1

Source: calculations based on ECB data

graph1

When looking at how the funds have impacted the real economy, the picture is mixed. Euro-area banks’ loans to non-financial corporations and households started to fall in 2012, and TLTROs appear to have stopped this decline. Since 2014 the stock has remained constant, but the programme has not managed to put us back to a high growth path of lending to the real economy.

Figure 2

Source: own calculations based on ECB data

graph2

TLTRO 2.0 will be conducted in 4 quarterly operations in June, September and December 2016 and in March 2017. Banks will be allowed to borrow an amount equivalent to up to 30% of their outstanding eligible loans on 31st January 2016, net of the funds from the previous TLTRO that they may still need to repay.

Assuming that there were no funds outstanding when the first operation of TLTRO 2.0 takes place, then euro-area banks could borrow  up to 1685 billion euros under this new programme. This assumption is reasonable as the ECB will allow banks to repay the old TLTRO in anticipation of the new programme starting. Again, allocations vary significantly across countries with Germany, France, Italy and Spain having the largest shares.

Figure 3

Source: own calculations based on ECB data

graph3

The most important change is to the structure in terms of leveraging and incentives. The initial interest rate applied to TLTRO 2.0 will be fixed for each operation at the rate applied in the main refinancing operations at the time of allotment (currently 0%).

However, banks whose net lending between 1 February 2016 and 31 January 2018 exceeds a certain benchmark will be charged a lower rate for the entire term of the operation. This lower rate will be linked to the interest rate on the deposit facility at the time of the allotment of each operation. This is currently negative, meaning that for some banks, borrowing under the TLTRO 2.0 could effectively take place at a negative rate.

Banks will receive the maximum rate reduction if they exceed their benchmark stock of eligible loans by 2.5%, as of 31 January 2018. Up to this limit, the size of the decrease in the interest rate will be graduated linearly, depending on the percentage by which banks exceed the lending benchmark.

How easy will it be to reach this benchmark? Based on the published details, it should not be very difficult. For banks whose net lending to firms and households was positive over the 12-month period to 31st January 2016, the benchmark for net lending is set at zero. So these banks would qualify for borrowing at negative rates as long as their net lending through 2018 remains positive, even if very small.

For banks whose eligible net lending was negative over the 12-month period to 31st January 2016, the benchmark for net lending is equal to the eligible net lending in that period. This means that banks could qualify for negative borrowing rates if they reduce the rate at which their lending is decreasing, without achieving positive net lending.

These conditions are the same as under the previous version of the programme, but it goes without saying that prize is higher now: a negative borrowing rate. Figure 4 shows which countries exhibited positive and negative net lending over the period considered.

Figure 4

Source: own calculations based on ECB data

graph 4

Will this measure be effective? Some have argued that that the ECB will just boost banks’ profits by allowing them to borrow at negative rates. It is worth pointing out that in a context where liquidity is abundant, the ECB automatically makes a profit by having a negative rate on the deposit facility and on the amounts of banks liquidity in excess of reserve requirements.

By having a negative borrowing rate on TLTROs, the ECB basically returns part of that profit to the banking sector. The relative balance for each bank will obviously depend on how much excess liquidity it has deposited compared to how much it lends. When banks borrow via TLTRO this creates an equal amount of reserves at the ECB (unless the funds are converted into cash).

On the reserves in excess of the minimum requirement, banks have to pay the same rate as on the deposit facility, i.e. -0.4%. The negative borrowing rate on TLTRO would act as compensation for the rate paid on excess reserves. If banks increased their lending enough to get the full interest rate discount on their TLTRO 2.0 borrowing (i.e. a rate of -0.4%) the two effects could be compensated.

Another element of this new programme could be more problematic. The previous version of the TLTRO included a mandatory requirement for banks to return the funds they had borrowed, in case they did not reach their lending benchmark.

TLTRO 2.0 on the contrary does not foresee any such mechanism. The reason for this change is unclear.It appears to contradict the rationale behind TLTRO lending, because those banks that do not increase lending to the economy would still be able to access plenty of liquidity at the 0% main refinancing operations rate without constraints.

President Draghi might have dropped a hint during the press conference, when he explicitly remarked that TLTRO 2.0 provides funding certainty, at an attractive price in an environment where volatility is high and there are high upcoming bank-bonds redemptions.

But while banks will certainly benefit from having liquidity available at negative rates in a potentially turbulent period for bond issuance, the rationale behind TLTRO lending was different. The whole idea (quoting from the ECB itself) was to “enhance the functioning of the monetary policy transmission mechanism by supporting bank lending to the real economy”.

By offering liquidity at negative rates, but eliminating completely the requirements for banks to return the funds when they do not achieve their lending benchmark, the ECB may in fact  be weakening the link between the provision of central bank liquidity and lending to the real economy that was at the centre of the TLTRO idea.

 


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 More on this topic More by this author

Blog Post

Developing resilient bail-in capital

Europe’s largest banks have made progress in issuing bail-inable securities that shelter taxpayers from bank failures. But the now-finalised revision of the bank resolution directive and a new policy of the SRB will make requirements to issue such securities more onerous for other banks. In order to strengthen banking-system resilience, EU capital-market regulation should facilitate exposures of long-term institutional investors.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: April 29, 2019
Read article More on this topic More by this author

Opinion

China’s debt is still piling up – and the pile-up is getting faster

With looser monetary policy, China's policymakers hope to encourage banks to lend more to the private sector. This seems to imply a change from the deleveraging drive begun in mid-2017. Although this should be good news for China's growth in the short term, such a continued accumulation of debt cannot but imply deflationary pressures and a lower potential growth further down the road.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: March 19, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: The case for a legislative remedy for recessions

Bruegel's Maria Demertzis welcomes Yale Law School professor Yair Listokin to this Director's Cut of 'The Sound of Economics', to discuss how law might be deployed as a macroeconomic tool to counter financial crisis.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: March 12, 2019
Read article More on this topic More by this author

Blog Post

Greening monetary policy: An alternative to the ECB’s market-neutral approach

The ECB’s market-neutral approach to monetary policy undermines the general aim of the EU to achieve a low-carbon economy. An alternative tilting approach would foster low-carbon production, accelerating the transition of the EU to a low-carbon economy, and could be implemented without undue interference with the chief aim of price stability.

By: Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: February 21, 2019
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: A greener monetary policy approach for the ECB

Bruegel fellow Dirk Schoenmaker walks Sean Gibson and 'The Sound of Economics' listeners through his latest working paper, focusing on how to make monetary policy in Europe more climate-friendly

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: February 21, 2019
Read article Download PDF More by this author

Working Paper

Greening monetary policy

The author proposes a tilting approach to steer the allocation of the Eurosystem’s assets and collateral towards low-carbon sectors, which would reduce the cost of capital for these sectors relative to high-carbon sectors. Central banks have already started to look at climate-related risks in the context of financial stability. Should they also take the carbon intensity of assets into account in the context of monetary policy?

By: Dirk Schoenmaker Topic: Energy & Climate, European Macroeconomics & Governance Date: February 19, 2019
Read article More on this topic More by this author

Blog Post

On Modern Monetary Theory

An old debate is back with a kick. The discussion around modern monetary theory first gained traction in the economic blogosphere around 2012. Recent interventions in the US and UK political arenas rekindled the interest in the heterodox theory that is now seeping into mainstream debates.

By: Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: February 11, 2019
Read article More on this topic

Blog Post

Whose (fiscal) debt is it anyway?

The authors map how much fiscal debt is in the hands of domestic and foreign holders in the euro area. While the market for debt was much more international prior to the crisis, this trend has since been reversed. At the same time, central banks have become important holders of fiscal debt.

By: Maria Demertzis and David Pichler Topic: European Macroeconomics & Governance Date: February 6, 2019
Read article More on this topic

Blog Post

The higher yield on Italian government securities is becoming a burden for the real economy

Francesco Papadia and Inês Gonçalves Raposo have recently written on Italian fiscal policy and the increase in the spread between Italian (BTP) and German (Bund) government. Since then, two developments have taken place: one good, and one bad. This blog post reviews them.

By: Francesco Papadia and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: February 5, 2019
Read article More by this author

Blog Post

What 2019 could bring: A look inside the crystal ball

Economic performance prospects in Europe, the US and Asia in 2019. We start off by reviewing commentaries and predictions about the euro zone, which many commentators expect to perform below potential as uncertainties continue to dampen a still robust recovery.

By: Michael Baltensperger Topic: European Macroeconomics & Governance, Global Economics & Governance Date: January 14, 2019
Read article Download PDF More on this topic

Policy Contribution

The euro as an international currency

Is a more important international role for the euro worth pursuing? What measures would achieve this result, if it is worth pursuing?

By: Konstantinos Efstathiou and Francesco Papadia Topic: European Macroeconomics & Governance Date: December 18, 2018
Read article More on this topic

Opinion

Can virtual currencies challenge the dominant position of sovereign currencies?

Marek Dabrowski and Lukasz Janikowski analyse why private money has historically failed in competition against sovereign currencies and what it means for modern virtual currencies, such as Bitcoin.

By: Marek Dabrowski and Łukasz Janikowski Topic: European Macroeconomics & Governance Date: December 15, 2018
Load more posts