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.

Read about event More on this topic
 

Upcoming Event

Jan
20
15:00

Monetary and fiscal policy interaction in times of Next Generation EU

Could Next Generation EU enable a better coordination of monetary and fiscal policy

Speakers: Lorenzo Bini Smaghi, Grégory Claeys and Hans Vijlbrief Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

Jan
27
16:00

In search of a fitting monetary policy: the ECB's strategy review

The ECB is reviewing its monetary policy strategy. How to ensure monetary policy is fit for purpose in a fast changing world?

Speakers: Maria Demertzis, Philip Lane, Reza Moghadam and Erik F. Nielsen Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF
 

Parliamentary Testimony

European Parliament

Monetary Policy in the times of corona: many unknown unknowns

Testimony to the European Parliament on monetary policy.

By: Maria Demertzis and Marta Domínguez-Jiménez Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: December 21, 2020
Read article More on this topic More by this author
 

Opinion

How to minimise the impact of the coronavirus on the economy

COVID-19 is a global killer. Austerity needs to succumb.

By: Rebecca Christie Topic: Global Economics & Governance Date: December 2, 2020
Read article More by this author
 

Podcast

Podcast

Steering the boat towards an unknown destination

Shocks pass, but change remains a constant. We need to start focusing on permanent changes in the economy and how to adapt to them.

By: The Sound of Economics Topic: European Macroeconomics & Governance, Global Economics & Governance Date: November 25, 2020
Read article Download PDF
 

External Publication

European Parliament

Monetary policy in the time of COVID-19, or how uncertainty is here to stay

The COVID-19 crisis has compounded the uncertainty that has come to characterise the European economy. We explore how this uncertainty manifests itself in terms of ECB decision-making and the long-run challenges the ECB faces.

By: Maria Demertzis and Marta Domínguez-Jiménez Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 12, 2020
Read article More on this topic
 

Blog Post

Growth uncertainty, European Central Bank intervention and the Italian debt

European Central Bank intervention provides a buffer against the uncertainty faced by European Union economies in the face of COVID-19. For the time being, this intervention has alleviated concern about Italy's debt, but without it Italy is vulnerable to a debt crisis.

By: Andrea Consiglio and Stavros Zenios Topic: European Macroeconomics & Governance Date: October 28, 2020
Read article Download PDF
 

External Publication

How Can the European Parliament Better Oversee the European Central Bank?

This paper, written at the request of the Committee on Economic and Monetary Affairs, assesses how the European Parliament holds the European Central Bank accountable. The same exercise is done for the Bank of Japan, in order to identify possible lessons for the ECB and the European Parliament.

By: Grégory Claeys and Marta Domínguez-Jiménez Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 23, 2020
Read about event
 

Past Event

Past Event

Bruegel Annual Meetings 2020 - Day 1

The Annual Meetings are Bruegel's flagship event which gathers high-level speakers to discuss the economic topics that affect Europe and the world.

Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 1, 2020
Read article Download PDF
 

Policy Contribution

Is the COVID-19 crisis an opportunity to boost the euro as a global currency?

The euro never challenged the US dollar, and its international status declined with the euro crisis. Faced with a US administration willing to use its hegemonic currency to extend its domestic policies beyond its borders, Europe is reflecting on how to promote it currency on the global stage to ensure its autonomy. But promoting a more prominent role for the euro is difficult and involves far-reaching changes to the fabric of the monetary union.

By: Grégory Claeys and Guntram B. Wolff Topic: European Macroeconomics & Governance, Global Economics & Governance Date: June 5, 2020
Read article More on this topic
 

Opinion

The Independence of the Central Bank at Risk

The ruling of the German Federal Constitutional Court (GFCC) of May 5 on the ECB’s monetary policy affects not only the relation of Germany to the European Central Bank (ECB) and the Court of Justice of the European Union (ECJ) but also the constitutional foundations of monetary policy.

By: Peter Bofinger, Martin Hellwig, Michael Hüther, Monika Schnitzer, Moritz Schularick and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 2, 2020
Read article Download PDF
 

Policy Contribution

COVID-19’s reality shock for external-funding dependent emerging economies

COVID-19 is by far the biggest challenge policymakers in emerging economies have had to deal with in recent history. Beyond the potentially large negative impact on these countries’ fiscal accounts, and the related solvency issues, worsening conditions for these countries’ external funding are a major challenge.

By: Alicia García-Herrero and Elina Ribakova Topic: Finance & Financial Regulation, Global Economics & Governance Date: May 28, 2020
Load more posts