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28 February 2019

Financial Times: The European refinancing dilemma

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Since 2014, the ECB has lent vast sums to the continent’s banks as part of a series of historically unprecedented interventions to boost the economy. Its so-called targeted longer-term refinancing operations (TLTRO) aim to provide banks with “stable and dependable funding in times of market uncertainty”, and incentivise them to lend more. The ECB is expected to make an announcement about these loans.

While quantitative easing has attracted far more attention, potentially because it comes with a more pronounceable acronym, the TLTROs are a similarly important part of the central bank's post-Eurozone crisis strategy.

They also pose a refinancing dilemma for the biggest recipients. According to Moody’s, TLTRO funding is equal to 6 per cent of total assets in the Spanish and Italian banking systems. If the scheme is not continued, banks in peripheral Europe will need to find funding elsewhere, at a time when market access (especially in Italy) is heavily constrained, or shrink their balance sheets.

The expectation is that the loans will be continued, if not necessarily in their current, generous form (where banks actually get paid to borrow if they increase their lending

The idea that TLTROs are needed to avoid weakness in peripheral banking systems seems a clear part of the approach. But the ECB’s Francois Villeroy de Galhau said in February that there needed to be a monetary policy case for a new round, and that the measures “cannot be designed for specific needs of some banks or some jurisdictions”.

The ECB, since 2014, has been responsible for bank supervision in the Eurozone. There is a “separation principle” dividing this role from its conventional monetary policy role.

The problem is that on the one hand, a withdrawal of funding from a banking system might curtail credit and constitute a monetary policy issue, and on the other it might force balance sheets to contract in a way that might relate to stability.

In other words, it is not only that the withdrawal of funding poses a stability risk to some banking systems, but that its existence in the first place signals the risk.

Full article on Financial Times (subscription required)

© Financial Times

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