Doubts regarding another relapse in the euro area have led its top monetary authority to make a move and implement an extensive package of unconventional monetary stimuli. The ECB hopes to revive growth in credit as the lynchpin to consolidating the economic recovery, reducing unemployment and, ultimately, normalising inflation. The ECB still has to combat significant elements but the firmness of its actions, slow but categorical (and in several cases surprising), means that it still has a decisive role in creating expectations of growth for the euro area.
To be able to analyse, in some depth, to what extent the latest measures announced might help to revitalise Europe's economy, it is useful to briefly review how the ECB's decisions affect the region's economic performance. In general, the most widely used monetary policy instrument is the interest rate for short-term refinancing operations, also known as the Refi rate. The cost of this liquidity affects the price at which banks can offer loans and reward savings. Under normal economic conditions, lowering the interest rate ends up encouraging consumption and investment as it reduces the return on savings and financing costs. However, the ECB has been forced to come up with imaginative formulas to continue stimulating economic activity as, with interest rates at their lowest possible level, the economy has yet to show any convincing signs of recovery. Following the same path taken by the Fed and Bank of England to raise the cost of savings, the ECB has not only cut interest rates to an all-time low but has also promised to maintain these rates at their current level for an extended period of time, commonly known as forward guidance. Through such action, the ECB hopes to reduce the return on savings even further, as well as the cost of long-term financing. The aim is still the same: to encourage consumption and investment as the necessary steps prior to a recovery in activity and, ultimately, inflation.
Given that credit plays a crucial role in this equation, in June the ECB took another step forward by announcing that, between September 2014 and March 2016, it would hold eight long-term refinancing operations (to be paid back in September 2018) at a very low interest rate (10 BPS above the Refi rate). This time, moreover, to ensure the liquidity injected reaches the so-called real economy, the amount each bank can borrow depends on the trend in credit. The first two targeted long-term refinancing operations or TLTROs (namely the one held in September and the one planned for December) have a maximum allocation of 7% of loans granted to the private sector1 at the end of April 2014. For the euro area as a whole, this totals 400 billion euros, 21% of which was already covered by the first operation. In the next few TLTROs, the amount that can be borrowed will depend directly on each bank's net lending during the months prior to the operation. Similarly, as an additional guarantee that the liquidity provided is used to improve the flow of credit to the private sector, those banks borrowing through these TLTROs must exceed specified benchmarks that will vary depending on each institution's loan portfolio.
Given that the economic outlook for the euro area as a whole not only did not improve but actually deteriorated significantly during the summer, in September the ECB surprised most analysts by announcing a corporate bond asset purchase programme, specifically asset and mortgage-backed securities. With regard to the former, which are the most innovative, Draghi stated that the ECB would consider purchasing simple and transparent securities backed by mortgages, loans to SMEs and consumer credit. He also stressed its readiness to buy from low-risk senior tranches to higher risk mezzanine tranches, but only if there is a guarantee for the latter. A lot of details still need to be clarified so that it is difficult to evaluate the real scope of this programme's impact. However, two relevant considerations can be made. Firstly, although Europe's securitisation market is small, especially when compared with the US, the ECB's actions could be the trigger required for considerable progress to be made over the next few years. Secondly, the success of this programme will depend on how far it manages to reactivate the credit capacity of financial institutions and one decisive factor will be whether banks can pass on a substantial level of risk with this programme.
Pending more details on the different measures the ECB has announced, a relatively simple and intuitive way to evaluate the impact these may have on credit is to analyse the trend in bank financing costs. We can use as a reference the trend in yield on senior debt which, as can be seen in the graph, very closely follows the movements in the Refi rate. Historically, a 100 BPS drop in the Refi rate has been associated with a 70 BPS drop in yield on bank senior debt. Since the aforementioned unconventional monetary policy measures were announced, yield on Europe's bank senior debt has fallen by 0.7 p.p.. Historically, a drop of this size, associated with a reduction in the Refi rate of 1 p.p., would lead to cumulative growth in loans to enterprises of 5.6 p.p. over two years.2 However, it is important to bear in mind several restrictions that would reduce such an impact. These figures were estimated during the period before the crisis, when the monetary policy transmission mechanism was fully functional, something which is not the case at present. This is precisely one of the reasons why the ECB has decided to act. Restrictions can currently be observed in both demand and supply. In the first case, the private sector is still deleveraging so that growth in credit would be seen in new loans while the loan portfolio will continue to shrink. On the supply side the restrictions are due to the recapitalisation taking place in European banks in order to meet the requirements of new regulations (see the article «The credit of credit» in this Dossier). All this means that the boost given to growth in credit will be less than if such restrictions had not existed.
In short, the ECB has gradually but firmly extended its battery of monetary policy measures to such an extent that it is now using tools that would have been unthinkable until quite recently. The bulk of the evidence suggests that their impact will not be negligible and they will help the incipient recovery in credit to consolidate over the coming quarters.
Ariadna Vidal Martínez
European Unit, Research Department, "la Caixa"
1. Specifically the eligible portfolio includes loans to the non-financial private sector, excluding mortgages to individuals.