Will the ECB venture into unknown waters?

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June 3rd, 2013

Within an environment of marked economic weakness and depressed inflation, at its meeting on 2 May the Governing Council of the European Central Bank (ECB) decided to cut the official interest rate to 0.5%, an all-time low. This step is significant because it confirms, once again, the ECB's desire to go on playing an active role in resolving the euro area crisis.

However, in spite of its resolute determination, the institution recognizes that the measures adopted to date are not being effective in reducing the persistent divergence in access to bank credit by firms (especially SMEs) among the different countries (see the Focus «Financial (re)integration in the euro area», in the Financial Markets section of this Monthly Report). The institution's concern was plain to see in its report on this meeting: «The Governing Council decided to start consultations with other European institutions on initiatives to promote a functioning market for asset-backed securities», also known as ABS. Going into more detail, Mario Draghi explained that there is a task force made up of the ECB, the European Investment Bank and the European Commission whose aim is to study possible measures to help revive the ABS market, especially those collateralized by SME loans.

Although reactivating the ABS market is no simple task, the European authorities have several alternatives that should not present any great technical difficulty. Firstly, the ECB could relax the criteria for an ABS to be accepted as collateral in its ordinary loan operations (as it already did in December 2011). However, Draghi's comments hint at the institution resorting to an innovative measure of greater scope. In this respect, a second alternative consists of carrying out further long-term refinancing operations (LTRO) collateralized specifically by SME loans. The maturities could be longer than 3 years and at a fixed interest rate. A third alternative being discussed is for the European Investment Bank to acquire SME loan portfolios, partly financed via the ECB. The option of the ECB directly buying up ABS seems to have been discarded.

Moving onto the area of interest rate policy, the ECB still has two alternatives available. The most obvious is to cut the official interest rate even further (the one for loan operations), although there is not much room left and the already very low levels call the effectiveness of this measure into question. The second, which would entail venturing into unknown waters, would be to set a negative deposit facility rate in order to encourage the circulation of surplus reserves. Although the ECB is highly unlikely to choose this option, Mario Draghi confirmed publicly that the institution is technically ready and in a position to cope with any possible adverse effects resulting from such a heterodox measure. In other words, it has not been ruled out.