On 5 June 2014 the European Central Bank announced Targeted Long-Term Repo Operations (TLTROs]. Their main purpose is to stimulate bank lending to non-financial corporations. The operations would offer conditional cheap funding to banks in large size and for maturities of up to four years. Private loan conditions should ease in response, particularly in the euro area periphery, but the impact on area-wide credit is uncertain. Also, TLTROs might effectively be used for government bond carry trades.

The below are excerpts from the ECB announcements and various research reports. Cursive lines and emphasis have been added.

The measures

“The Governing Council of the ECB has today announced measures to enhance the functioning of the monetary policy transmission mechanism by supporting lending to the real economy [through] a series of targeted longer-term refinancing operations (TLTROs) aimed at improving bank lending to the euro area non-financial private sector…[and] preparatory work related to outright purchases of asset-backed securities” [ECB press release, 5 June 2014]

Counterparties will be entitled to an initial TLTRO borrowing allowance equal to 7% of the total amount of their loans to the euro area non-financial private sector, excluding loans to households for house purchase, outstanding on 30 April 2014 [amounting to roughly EUR400 bn or 3% of euro area GDP] . In two successive TLTROs to be conducted in September and December 2014, counterparties will be able to borrow an amount that cumulatively does not exceed this initial allowance. During the period from March 2015 to June 2016, all counterparties will be able to borrow additional amounts in a series of TLTROs conducted quarterly. These additional amounts can cumulatively reach up to three times each counterparty’s net lending [new loans minus loan redemptions] to the euro area non-financial private sector… All TLTROs will mature in September 2018. The interest rate on the TLTROs will be fixed over the life of each operation at the rate on the Eurosystem’s main refinancing operations (MROs) prevailing at the time of take-up, plus a fixed spread of 10 basis points.” [ECB press release, 5 June 2014]

“What is in this LTRO, in this TLTRO that makes it different? Several things; The cost, obviously it’s very low. The term maturity is four years. And the determination that this money not be spent on sovereigns and on sectors that are already experiencing or are just coming out of a bubbly-ish situation…The underlying spirit is that we want to enhance lending to the non-financial companies in the private sector. Also there are several provisions here that would require enhanced reporting on the use of the initial allocation and on the use of the quarterly allocations. So there will be checks…. The second intention is not to interfere with the AQR [Asset Quality Review] and the comprehensive assessment [of the euro area bank system in preparation for the Single Supervisory Mechanism]. And the third is not to incentivise the weak banks.” [Mario Draghi, 5 June 2014]

The expected impact

“[The TLTRO] creates incentives for banks to grow their ‘real economy’ loan books. One of the problems with the Fed’s QE program has been the weakening of loan growth. Large firms and mortgage holders, who were able to refinance, certainly benefited from QE, but some of the biggest beneficiaries were asset management firms.” [SoberLook.com, 6 June 2014]

“The ‘funding for lending scheme’ put in place by the ECB is quite generous to start with as 1/ it includes existing loans for two of the repo operations; 2/ there is some leverage in the repo of the 2015 onwards operations; 3/ the rate charged at each operation is fixed. It may only vary from one operation to the other… These two TLTROs have been targeted to support lending to the real economy and avoid carry trades through at least the following disincentives: 1/compulsory reimbursement after two years, and 2/ no access to the 2015 TLTRO, if the operations do not result in new lending to non-financial corporations in the proportion defined by the ECB.” [Laurence Boon, Chief Europe Economist, BAML, 6 June 2014]

“How much will [the TLTRO] impact the credit conditions?…We estimate the breakdown of the EUR400bn by country and bank. EUR155bn is GIIPS [Greece, Italy, Ireland, Portugal, and Spain] including EUR54bn for Spain and EUR75bn for Italy. Our initial view is that the take up in Spain and Italy will be significant. We assume Tier 1 banks will only use a small percent of their sheets, but Tier 2 & 3 far more. On initial estimates, in Spain this could reduce SME costs by about 30- 80bps, in Italy 20-40bp as the SME loan book is much larger.” [Morgan Stanley Research, 6 June 2014]

The doubts

“Questions remain over how far the TLTROs will be successful in stimulating lending, when demand for loans is weak and the operations will not take place until September and December, delaying any positive impact on lending…That said, euro-area banks will be incentivised to lend, the sums are potentially large and the terms are generous. By Q4-2014 the ECB’s balance-sheet assessment process will be over and banks may be feeling more willing to lend.” [Standard Chartered Global Research, 5 June 2014]

Liquidity is not a binding constraint on bank lending in jurisdictions with credit-worthy borrowers, and there is a risk that targeted liquidity programs could undermine the development of private securitisation markets, which are needed in order to facilitate risk transfer and capital relief.” [Barclays Credit Research, 6 June 2014]

“Banks which do not meet the ECB’s corporate lending target in the next two years will not be required to pay punitive interest to the ECB (a measure which observers had expected in the run-up to the meeting), but only to repay the funds borrowed from the ECB. In other words: The ECB offered the banks a fixed-rate tender with a maturity of more than two years without any additional restrictions today – a very attractive opportunity from the banks’ vantage point.” [Joerg Kraemer, Chief Economist Commerzbank, 6 June 2014]

“The impact of this new ‘TLTRO’ remains uncertain…[i] there is nothing in the documentation released today that would prevent banks from using the proceeds to accumulate more [government bonds], at least for the first two years. They would merely be forced to pay down the TLTRO half way through the operation if they fail to step up their lending to the private sector, at no extra cost… [ii] substantially reducing banks’ medium-term funding cost can be fully passed to final borrowers only if banks consider that they are comfortable with the current level of their interest margins on lending to the private sector. They have been increasing sharply since mid-2012. Banks may want to raise them further… [iii] banks need to repay the ECB some EUR450bn by February 2015, as the two LTROs expire. Even if they were to use the entirety of their EUR 400bn initial allotment in the TLTRO to fund this, there would still be a net gap of some EUR50bn. In a cynical view of the targeted LTRO, it could be considered as simply a four-year extension of the existing LTRO, at a slightly cheaper cost (25 bps against c.65 bps) and with more visibility on the final cost.” [Gilles Moec and Mark Wall, Deutsche Bank, 5 June 2014]