FRANKFURT/PARIS (Reuters) -
The European Central Bank is hoping a new round of
long-term loans will be used by banks to drive down
borrowing costs - a substitute for an asset-purchase
scheme of its own which would avert a potentially
damaging internal split.
The ECB unveiled the loans plan last month as part of a package of
measures to breathe life into a sluggish euro zone economy, where
inflation is running far below the central bank's target and there
is a dearth of credit to smaller firms.
Presented as a means to foster bank lending to businesses, the
scheme is in fact a hybrid program that also offers banks access to
cheap funding for four years with which they can buy financial
Policymakers hope that in the round it will create a "credit
multiplier" effect, tantamount to enabling the private sector to
embark on quantitative easing (QE) - creating money to buy assets to
keep borrowing costs low and boost spending - on the ECB's behalf.
"It's loans but not only loans," ECB Executive Board member Peter
Praet said of the funding program.
"It's also the liquidity injection, the funding substitution," he
told Reuters in Paris on Wednesday.
The idea is that one or more of three things will happen:
Banks will use the money to lend to households and businesses,
thereby directly helping to revive the economy; they take the money
and buy assets themselves; they use the funds to substitute for
issuing their own debt.
The latter two could lower the funding costs for all banks, even
those who don't take the ECB's money, and spill over into looser
conditions in the broader corporate credit market, hopefully making
money cheaper and easier to access.
In a speech in Paris on Wednesday, Praet said the loans plan, or
TLTRO, "has the potential to halt the vicious circle of constrained
lending, weak macroeconomic conditions and elevated loan
delinquencies, and re-ignite a positive 'credit multiplier'
Under the plan, banks can borrow up to 400 billion euros ($545
billion) in September and December at a slight premium to the ECB's
regular funding operations. They have subsequent opportunities
running through to mid-2016 to take additional loans.
Banks that have shown positive net lending between April of this
year and the new funding operation can borrow up to three times
their net new lending in that window and keep the money until 2018,
so long as they continue to increase lending.
The terms of the plan do not stipulate, however, that banks must
devote all the ECB loans to new lending, allowing the possibility of
using some of the money for their own funding purposes or to buy
"They are offering banks very cheap funding and asking the banks to
expand their balance sheets, and in the process they will create
money and they will buy assets," said RBS economist Richard Barwell.
"That will look an awful lot like what the ECB might have done
themselves," he said. "But it won't be the ECB buying the assets, it
will be the private sector buying the assets. So to me it looks a
lot like arms-length QE."
Quantitative easing involves a central bank buying financial assets
from banks and other private institutions with newly-created money,
thereby increasing the amount of cash sloshing around an economy
which should make it cheaper to borrow and easier to spend.
The money from the TLTROs (targeted longer-term refinancing
operations) will eventually be repaid but it will expand the euro
zone's money supply for four years.
BARRIERS TO QE
At the ECB, hopes are being pinned on the long-term loan operation
to deliver the goods.
"We've taken decisive action in June, if this is not enough we will
do more but we have no reason to believe this will not be enough,"
ECB board member Benoit Coeure said on Wednesday.
But what if the plan doesn't make a significant difference?
Many banks are in risk-off mode as they shape up for ECB health
checks before the central bank takes over supervision of Europe's
bigger lenders from November. And there is no guarantee they will
loosen up on lending thereafter.
There is also the question as to whether there is corporate and
consumer demand for a lot of new borrowing.
"I think the big headwind on the credit multiplier is the banks
themselves," said Sassan Ghahramani, CEO of New York-based SGH Macro
Advisors, which advises hedge funds.
"It's a terrible environment for them," he said with reference to
the ECB health check and pressure for capital restructuring.
"Undoubtedly it (the TLTRO) is going to help rather than harm. The
question is the multiplier issue – there is a bottleneck with the
The ECB also wants the plan to work as the barriers to the central
bank embarking on an asset-purchase program itself are high.
Sabine Lautenschlaeger, a former Bundesbank vice president who now
sits on the ECB's Executive Board, the nucleus of the broader
policymaking Governing Council, said on Monday a broad ECB
asset-buying plan should only be unleashed in an emergency such as
the imminent threat of deflation.
"Such risks are, however, neither perceptible nor do we expect
them," she said.
Hours after ECB President Mario Draghi's news conference last
Thursday where he said the ECB could yet do more to loosen policy
and that there was unanimous agreement to do so if necessary,
Bundesbank chief Jens Weidmann responded that interest rates should
not be left too low for too long.
SMALL WINDOW OF OPPORTUNITY
Even those less opposed see no prospect of unleashing QE soon. The
consensus among ECB policymakers is that they must first allow the
package of measures announced in June - which included cuts to all
the main interest rates - to take effect and that this will take
them into next year.
Even if the Council were to favor QE in 2015, the global policy
environment might make embarking on such a policy tricky as the U.S.
Federal Reserve is expected to start raising interest rates around
the third quarter.
A tightening of Fed policy would lead to a repricing of risk and
could prove a difficult environment for the ECB to head firmly in
the opposite direction, according to people familiar with the ECB's
That leaves a potentially small window of opportunity and means the
TLTRO really needs to work.
"We will implement what we decided in June including the targeted
long term refinancing operation and we are very confident that this
will help," Coeure said.
One consequence could be to generate a so-called 'portfolio
rebalancing effect' whereby banks use TLTRO funds to partially
substitute for issuing their own bonds.
Praet said in Paris that via such a substitution effect "the TLTROs
can create a scarcity of investible assets, which will result in
lower yields and easier market funding conditions even for banks
that have not taken part in the operations".
If banks take the ECB money and issue fewer of their own bonds as a
result, so the logic goes, then the diminished supply will push up
prices and lower yields on bank bonds.
"It may also create spillover effects to other segments of the
corporate credit market, as investors in bank bonds will be induced
- by a scarcity of supply – to diversify away from that market and
re-invest in other market segments," Praet said.
A downside of the ECB's plan is that it cannot fully control what
banks choose to do with the new money.
Aside from fulfilling their obligation to keep their lending on an
upward trajectory, banks can choose to fund themselves or buy assets
with the cheap ECB money as they like.
But that may be a price worth paying to avoid a bloody battle over
printing money which, for some in the ECB, remains the ultimate
"There is a compromise here," said Barwell at RBS.
"They (the ECB) have given up essential control over what assets are
bought and what the final impact will be but they've avoided having
to call the shots themselves – they've avoided that endless debate
about what to buy and whether QE would allow politicians to drag
their feet on reforms."
($1 = 0.7331 Euros)
(Additional reporting by Deepa Babington and Renee Maltezou in
Athens. Editing by Mike Peacock)