The European Central Bank is throwing every tool it has at the sluggish euro-zone economy. Starting in September, it’ll make a generous funding offer to lenders in the region, returning to an approach it’s used twice before in the past five years. It’s also considering tweaking its interest-rate policy to limit the punitive side effect of its stimulus.
1. What’s the ECB doing for banks?
It’s reviving a program called Targeted Longer-Term Refinancing Operations. TLTROs, as they’re known, are aimed at getting financial institutions to step up lending to companies, so stimulating economic activity and creating jobs. Banks can always borrow short-term from the ECB, but TLTROs are special: cheaper and with a longer maturity.
2. How does the targeting work?
The amount a bank can borrow from the ECB under the program depends on the size of its loan book to the private sector, mortgages excluded. Initially, the interest rate will be set 10 basis points above the ECB’s main refinancing rate, which is currently zero. If a bank lends enough money on to companies and households to meet a goal set by the ECB, it is rewarded with a cheaper interest rate. That can fall to as low as 10 basis points above the deposit rate, which is currently minus 0.4% and looks set to fall further.
3. It sounds like a subsidy in disguise. Is it?
It’s barely disguised. ECB President Mario Draghi himself said that “if there were no subsidies, then nobody would take up the TLTROs.” But there’s another incentive as well: letting them borrow at a subzero rate partially offsets the pain policy makers have inflicted with the negative deposit rate.
4. How does the negative deposit rate hurt banks?
Banks profit when they charge more for loans than they pay for customer deposits. Yet the ECB’s negative rate policy has driven all interest rates lower -- including those on bank loans. At the same time, financial institutions are effectively paying to keep their excess reserves at the central bank. To maintain their profit margin, they should ideally impose a negative rate on customer deposits. That’s a radical step though and, with very few exceptions, it’s proved impossible.
5. What else could the ECB do about this?
Officials are studying several measures, the most well-known of which is called tiering. That involves exempting or applying a less negative rate to some of the deposits banks park at the ECB overnight. The Bank of Japan uses a similar model, with a three-tier design that uses a zero rate for most funds.
6. Why is the ECB reviving TLTROs now?
The key reason is that inflation in the euro area is too far below the ECB’s goal of just under 2%, and an economic rebound anticipated for the second half of 2019 is unlikely to materialize. The loans will also help banks meet rules adopted after the 2008 financial crisis which stipulate that they must hold a certain amount of equity or longer-term funding. Previous TLTROs qualified but as those programs expire, some banks need replacement funding. Borrowing from the ECB will generally be cheaper than raising money in financial markets.
7. How is the tool supposed to rekindle inflation?
Banks are supposed to use the cash from the TLTROs to fund loans to consumers and businesses. That should boost consumption and investment, creating jobs which further boost demand, and so drive up prices. That’s the idea, anyway.
8. Did this work the last time?
The ECB argues that past rounds of TLTROs achieved their intended goal of passing on cheaper borrowing costs to the private sector. Inflation, on the other hand, remained subdued -- and there is some skepticism now as to how much the new round will help. Italian and Spanish banks already borrowed close to the maximum amount under TLTRO II and financing conditions in Germany and France are exceptionally favorable already.
9. What are the risks?
One concern is that banks may become too reliant on the ECB for long-term funding, making an eventual return to a normally functioning financial market much harder. The central bank is trying to counteract that by offering only two-year loans, compared with previous rounds where the loans could be held for four years. TLTROs could also potentially slow the process of reducing non-performing loans in countries like Italy. The ECB’s loose monetary policy is sometimes blamed for propping up unprofitable businesses -- so-called zombie firms -- that couldn’t survive in a more “normal” environment.
10. What are other options?
The ECB has cut interest rates so low and bought up so many bonds that it may be getting close to the end of the road for monetary policy. That means it might be time for European governments -- especially those with healthy budgets such as Germany -- to move away from austerity and start spending more. ECB policy makers repeatedly urge countries with fiscal space to use it.
To contact the reporter on this story: Kristie Pladson in Frankfurt at firstname.lastname@example.org
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