Recent economic data indicates that the Eurozone’s economy is slowly improving. However credit flows are weak and lending rates have risen. By offering cheap loans through the LTRO, the ECB helps to reduce the cost of borrowing for banks, which should trickle down to bank lending products. This however should not be a bank bailout. Perhaps it is easier to view it as a well designed business bailout. There is increased speculation that the ECB might offer another round of cheap, long-term loans to banks to keep the cost of credit down to safeguard the weak, fragile, uneven economic recovery and help foster growth. Credit flows are weak and the cost of commercial borrowing has almost doubled, despite the low interest rate environment. The ECB stands ready to help. “Weak, Fragile, Uneven”
No truer words have been spoken. This is how the European Central Bank president Mario Draghi described the economic recovery in the Eurozone. He also cautioned that further support for the banking sector could not be ruled out and the ECB was “ready to consider all available instruments” to maintain financial stability and safeguard the economic recovery in the Eurozone.
These comments added to the speculation that the ECB might offer another round of cheap, long-term loans to banks to keep the cost of credit down. Should this transpire, it would be the third consecutive year for the central bank to offer LTRO, or long-term refinancing operation, to Eurozone banks.
Over the past two years, the ECB lent about EUR1 trillion to bolster banks balance sheets and enhance liquidity. While about of half of LTRO has been paid back, it appears that Eurozone banks may need more help to manage through the ongoing stressed environment.
Recent economic data indicates that the Eurozone’s economy is improving at a sluggish rate, however credit flows are weak. Bank lending to businesses, especially small to mid sized companies is still quite anemic. Banks are reluctance to lend which negatively impacts economic expansion as many businesses do not have the ability to raise external funding.
Moreover, commercial lending rates have risen despite the ECB’s guidance that it will hold rates at a record low of 0.5%. This divergence previously occurred during the crisis, when liquidity was less available to banks and thus their cost of borrowing rose. By offering cheap loans through the LTRO, the ECB helps to reduce the cost of borrowing for banks, which should trickle down to lending products.
Certainly, inflation is not triggering higher interest rates. Inflation in the Eurozone has fallen to 1.1%, which is the lowest level in more than three years and well below the ECB’s target of keeping inflation below or close to 2%. So, there aren’t many indicators pointing to an imminent rate rise.
But a key measure of funding costs for Eurozone banks, the three-month Euribor, which is the rate that banks borrow money for three months, has basically doubled to 0.225% since last year. By comparison, despite the US troubles, three-month money costs significantly less, approximately 0.09% for commercial lending. A rise in funding costs could affect the ability of many weaker smaller firms to stay afloat. Since it’s not entirely clear that the money lent to banks finds its way to these businesses, if LTRO3 is announced, it could be for longer duration loans or even be tied to lending to small firms.
While programs like LTRO may be objectionable to many politicians and the general public, as these programs are often viewed as bank bailouts, the larger picture benefits for small to mid sized businesses and the overall economic environment are quite clear. The benefits of programs that are designed to safeguard economic growth and the overall economic wellbeing of the Eurozone certainly outweigh the short-term costs, as the banks will, honour their obligations, and repay the LTRO funds, with interest.
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