Blog Post

T-LTRO: variation on a (ECB’s) theme

Last Thursday the ECB unveiled its “big bazooka plan” to fight the threat of deflation in the Euro area. Among the measure announced, there is a variation on a theme that by now is a classic for the ECB, i.e. the Long-Term Refinancing Operation (LTRO). The 2014 version of the LTRO will be Targeted (TLTRO), spicing the usual LTRO up with a flavor of Bank of England-like “funding for lending”. The scheme works in two steps, with a first phase linked to the outstanding amount of banks’ loans to the non-financial private sector and a second phase linked to the flow of net lending. However, important details remained to be clarified.

By: Date: September 20, 2014 Topic: Banking and capital markets

Last Thursday the ECB unveiled its “big bazooka plan” to fight the threat of deflation in the Euro area. Among the measure announced, there is a variation on a theme that by now is a classic for the ECB, i.e. the Long-Term Refinancing Operation (LTRO). The 2014 version of the LTRO will be Targeted (TLTRO), spicing the usual LTRO up with a flavor of Bank of England-like “funding for lending”. The scheme works in two steps, with a first phase linked to the outstanding amount of bank loans to the non-financial private sector and a second phase linked to the flow of net lending. However, important details remained to be clarified.

Phase 1

Two TLTRO operations conducted in September and December 2014 will allow banks to borrow up to an initial allowance. The latter is defined as 7% of the amount of banks’ outstanding loans to the euro area non-financial private sector (excluding households’ mortgages) as of end-April 2014. Funds will have 4 years maturity and a fixed rate equal to the MRO rate +10 basis points.

In terms of size, 7% of the euro area outstanding loans to the non-financial private sector amounts to roughly 400bn

In terms of size, 7% of the euro area outstanding loans to the non-financial private sector amounts to roughly 400bn. As a comparison, the deleveraging occurred in credit (with the definition used by the ECB for the TLTRO) amounts to 531bn in the euro area as a whole since fall 2011, i.e. when deleveraging really kicked in in Europe. Due to the exclusion of mortgages – which make up to 74% of total credit to households as of April 2014 – this is mostly corporate deleveraging. Considering only the corporate sector, outstanding loans have in fact decreased by 426bn between November 2011 and April 2014. Therefore, at the aggregate level the initial allowance under the ECB TLTRO is almost equal to the decrease in loans observed since fall 2011.

At the country level things are very different. The bulk of corporate deleveraging between November 2011 and today has occurred in Spain (-264bn) followed by Italy (-91bn) and Portugal (-22bn). In France outstanding loans to corporates decreased by 15bn and in Germany by only 7bn. The TLTRO initial allocation however will not follow this ranking, and will be concentrated mostly in Germany (95bn or 24% of the total), France (77bn or 19% of the total), Italy (75bn or 19% of the total) and Spain (54bn or 14% of the total).

Phase 2

Between March 2015 and June 2016, banks will be able to borrow additional amounts in a series of TLTROs conducted quarterly and depending on banks’ net lending to the real economy. In fact, these additional amounts can cumulatively reach up to three times each bank’s net lending to the euro area non-financial private sector (excluding households’ mortgages) provided between 30 April 2014 and the respective allotment reference date in excess of a specified benchmark. The benchmark will be determined “by taking into account each counterpart’s net lending recorded in the 12-month period up to 30 April 2014”. The rate will again be fixed and equal to the MRO rate +10 basis points.

This second component of TLTRO is very important because it allows “leveraging” of the measure beyond the initial allowances and it explicitly introduces a link with the flow of net lending, thus going in the direction to address a major flaw of the previous LTROs where funds were largely used to buy government bonds.

How tight is the net-lending criterion for TLTRO funds? In practice, not so much

But how tight is the net-lending criterion? In practice, not so much. Figure 3 shows a 12-month cumulative flow of lending to the non-financial private sector (excluding households mortgages) for the euro area, as well as the four biggest countries. During the twelve months up to April 2014 (i.e. the period that will be used for the benchmark) net lending has been negative in the euro area, as well as in Italy and Spain, and almost inexistent in Germany and France. As noted among others by Frederik Ducrozet of Crédit Agricole, this means it should be rather easy for banks to meet the net lending benchmark. De facto in Italy and Spain, net lending will “just” need to be “less negative”, i.e. the pace of deleveraging in the corporate loan portfolio will just need to be slowed and not necessarily reversed. This is what can be said based on the current information available, but the ECB has mentioned that further details (possibly clarifying this point) will be released at a later stage.

All TLTROs will mature in September 2018, meaning that liquidity injected under the type-one operations will have maturity of four years whereas liquidity injected under the type-two operations will have maturity of three/two years. Starting 2 years after each TLTRO, counterparties will have the option to repay any part of the amounts at a six-monthly frequency.

The ECB must be very careful in clarifying these “details” as soon as possible. Otherwise it would just be the same music over again

Quite obviously, the most important and delicate part of the scheme is the safeguard mechanism to ensure that the funds are actually used for the purpose they are intended to, i.e. lending to the real economy. At the moment, this is not yet entirely clear. The ECB press release says that banks will be required to pay back the funds borrowed under phase 1 of the TLTRO as early as September 2016 (i.e. 2 years before maturity), if their net lending will be below the benchmark during the period from 1 May 2014 to 30 April 2016. However, as noticed by market analysts, nothing explicitly prevents banks from using the funds of the TLTRO to buy government bonds. According to the information available up to this point, Spanish and Italian banks could use part of the funds borrowed in Phase 1 to buy government bonds and still qualify for Phase 2, as long as their loan portfolio does not shrink faster than it has been shrinking over the last 12 months. And even in case they were not to qualify for Phase 2, 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. ECB’s president Draghi has said in the Q&A that “there are going to be additional reporting requirements”, which are probably part of the “details” the ECB will publish at a later stage. The TLTRO can be a positive improvement on an established ECB instrument, potentially remedying its major flaw. For this to be the case, however, the ECB must be very careful in clarifying these “details” as soon as possible. Otherwise it would just be the same music over again. 


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.

Read about event More on this topic
 

Upcoming Event

May
25
14:30

How can we support and restructure firms hit by the COVID-19 crisis?

What are the vulnerabilities and risks in the enterprise sector and how prepared are countries to handle a large-scale restructuring of businesses?

Speakers: Ceyla Pazarbasioglu and Guntram B. Wolff Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

May - Jun
31-1
10:30

MICROPROD Final Event

Final conference of the MICROPROD project

Speakers: Carlo Altomonte, Eric Bartelsman, Marta Bisztray, Italo Colantone, Maria Demertzis, Wolfhard Kaus, Javier Miranda, Steffen Müller, Verena Plümpe, Niclas Poitiers, Andrea Roventini, Gianluca Santoni, Valerie Smeets, Nicola Viegi and Markus Zimmermann Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article
 

Blog Post

Now is not the time to confiscate Russia’s central bank reserves

The idea of confiscating the Bank of Russia’s frozen reserves is attractive to some, but at this stage in the Ukraine conflict confiscation would be counterproductive and likely illegal.

By: Joshua Kirschenbaum and Nicolas Véron Topic: Banking and capital markets, Global economy and trade Date: May 16, 2022
Read about event
 

Past Event

Past Event

[Cancelled] Shifting taxes in order to achieve green goals

[This event is cancelled until further notice] How could shifting the tax burden from labour to pollution and resources help the EU reach its climate goals?

Speakers: Niclas Poitiers and Femke Groothuis Topic: Green economy, Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 12, 2022
Read about event More on this topic
 

Past Event

Past Event

How are crises changing central bank doctrines?

How is monetary policy evolving in the face of recent crises? With central banks taking on new roles, how accountable are they to democratic institutions?

Speakers: Maria Demertzis, Benoît Coeuré, Pervenche Berès, Hans-Helmut Kotz and Athanasios Orphanides Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 11, 2022
Read article Download PDF More by this author
 

Book/Special report

European governanceInclusive growth

Bruegel annual report 2021

The Bruegel annual report provides a broad overview of the organisation's work in the previous year.

By: Bruegel Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: May 6, 2022
Read article Download PDF
 

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article More by this author
 

Blog Post

Owning up to sustainability risks: the EU should champion international standards

To keep European Union capital markets open and integrated, new international standards should be reflected in future European law and accounting practice to provide further incentives for a reallocation of capital, reflecting in particular climate risks.

By: Alexander Lehmann Topic: Banking and capital markets, Green economy Date: April 26, 2022
Read article Download PDF More on this topic
 

Working Paper

The low productivity of European firms: how can policies enhance the allocation of resources?

A summary of the most important policy lessons from research undertaken in the MICROPROD project work package 4, related to the allocation of the factors of production, with a special focus on the weak dynamism of European small and medium-sized enterprises (SMEs).

By: Grégory Claeys, Marie Le Mouel and Giovanni Sgaravatti Topic: Macroeconomic policy Date: April 25, 2022
Read article More by this author
 

Podcast

Podcast

War in Ukraine: sanctions on Russia two months in

A further look into sanctions on Russia and the implications for the global financial system.

By: The Sound of Economics Topic: Banking and capital markets, European governance Date: April 22, 2022
Read article
 

Blog Post

The European Union should sanction Sberbank and other Russian banks

Sanctions on Sberbank and most other Russian banks should be imposed by the EU, without delay and at no major cost to either itself or like-minded countries, while it ponders an oil and gas ban.

By: Joshua Kirschenbaum and Nicolas Véron Topic: Banking and capital markets, Global economy and trade Date: April 15, 2022
Read article More on this topic
 

External Publication

What drives implementation of the European Union’s policy recommendations to its member countries?

Article published in the Journal of Economic Policy Reform.

By: Konstantinos Efstathiou and Guntram B. Wolff Topic: Macroeconomic policy Date: April 13, 2022
Load more posts