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TLTRO: how well has the ECB targeted its loans?

Summary:
The European Central Bank has revealed the details of arguably the most important element of the package of extraordinary monetary policy measures it unveiled last month to rid the eurozone of the threat of deflation. On Thursday, the ECB announced exactly how its targeted longer-term refinancing operation, or the TLTRO, will work. Earlier forward guidance that rates were likely to remain on hold until the end of 2016 was watered down by Mario Draghi, ECB president, possibly in the hope that this would raise the take-up of the TLTRO funds. Mr Draghi also revealed that banks would be able to borrow up to €1trn from the central bank, should they smash targets, or benchmarks, set by the ECB. Lenders are already able to borrow an initial amount of 0bn in two auctions, scheduled for September and December. The €400bn figure corresponds to 7 per cent of their lending books to businesses and households, excluding mortgage loans. The aims The detail of the operation is crucial to achieving its aim of spurring lending to credit-starved smaller businesses in the bloc’s periphery. The ECB wants to discourage banks from using the cheap public funds to buy sovereign bonds or fuel real-estate bubbles. But, while banks must repay the cash after two years if they do not meet their lending benchmarks, there are no penalties if their sovereign debt holdings rise substantially.

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TLTRO: how well has the ECB targeted its loans?

The European Central Bank has revealed the details of arguably the most important element of the package of extraordinary monetary policy measures it unveiled last month to rid the eurozone of the threat of deflation.

On Thursday, the ECB announced exactly how its targeted longer-term refinancing operation, or the TLTRO, will work. Earlier forward guidance that rates were likely to remain on hold until the end of 2016 was watered down by Mario Draghi, ECB president, possibly in the hope that this would raise the take-up of the TLTRO funds.

Mr Draghi also revealed that banks would be able to borrow up to €1trn from the central bank, should they smash targets, or benchmarks, set by the ECB. Lenders are already able to borrow an initial amount of $400bn in two auctions, scheduled for September and December. The €400bn figure corresponds to 7 per cent of their lending books to businesses and households, excluding mortgage loans.

The aims

The detail of the operation is crucial to achieving its aim of spurring lending to credit-starved smaller businesses in the bloc’s periphery. The ECB wants to discourage banks from using the cheap public funds to buy sovereign bonds or fuel real-estate bubbles.

But, while banks must repay the cash after two years if they do not meet their lending benchmarks, there are no penalties if their sovereign debt holdings rise substantially. The ECB believes that banks will not use the funds to buy more sovereign debt since they could already do this more cheaply using other funding sources such as the central bank’s regular fixed-rate full allotment auctions, which run until the end of 2016.

Some analysts, however, were sceptical that there was much of an incentive for banks to expand their lending to businesses.

Marchel Alexandrovich, Jefferies International:

The hurdle to benefiting from ECB’s money for the full four years does not look particularly challenging.

Richard Barwell, Royal Bank of Scotland:

I don’t have a problem with the LTRO. It’s the T I have a problem with. This is supposed to increase lending, but there are no meaningful incentives to lend.

The benchmarks

Whether they participate in the auctions alone, or in groups, banks must stick to the lending benchmarks if they are to receive the funding at the fixed rate of 0.25 per cent for four years. Otherwise, they have to pay it back two years ahead of schedule.

In calculating the benchmarks, banks will be split into two categories: lenders which have expanded their loan book to businesses and households (though not for mortgages) over the 12 months to April 2014, and those that have contracted lending.

Lenders that have expended their loan book will have to at least maintain lending to businesses and households at that level over the two years to April 2016.

TLTRO: how well has the ECB targeted its loans?

For analysts, this looks an easy target to hit. “The ECB is asking banks to do less than they managed to do on their own in a more challenging environment,” said Mr Barwell. “Talk about making them work for the money.”

There are fewer banks that are expanding, than are contracting their balance sheets, however. For lenders that have been shrinking their loans to businesses and households, the pace of contraction in the 12 months to April 2014 can be maintained over the next year, but must not fall further before April 2016.

TLTRO: how well has the ECB targeted its loans?

In the middle of 2016, the ECB will test participants against the benchmarks.

If banks exceed the target, they can claim three times lending over their benchmark in the six auctions, to be conducted in 2015 and 2016. This could enable banks to borrow an additional €600bn. The official releases are here.

Claire Jones
Claire Jones is the FT's Eurozone economy correspondent, based in Frankfurt. Prior to this, she was an economics reporter in London. Before joining the Financial Times, she was the editor of the Central Banking journal. Claire studied philosophy and economics at the London School of Economics.

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