March 1, 2019

Understanding Targeted Longer-Term Refinancing Operations

With speculation of a third round of Targeted Longer-Term Refinancing Operations (TLTROs), understanding how they’ve been implemented and how they’ve performed is essential to see just how this program might be extended. According to the European Central Bank, TLTROs “are Euro system operations that provide financing to credit institutions for periods of up to four years.” Their purpose, according to the ECB, is to help European countries’ banks provide more lending to all segments of the economy.

TLTRO Origins

As a reaction to the sovereign debt crisis, the ECB created the TLTRO program to help increase liquidity and reduce the chances of European sovereign debt defaults. One notable takeaway of the proposal for TLTRO III is to base the interest rate that European banks pay on the proportion of loans they make to individuals (excluding for residential real estate) and to businesses outside the financial industry. The greater percentage of these types of loans made, the more favorable interest rates European banks could expect from the ECB.

The first round of TLTROs became public on June 5, 2014, and a second round began on March 10, 2016. With approximately 722 billion Euros of long-term lending from the ECB slated to begin maturing in 2020 and an uncertain legal and economic environment, European banks are likely to face challenges when looking to refinance replacement funds when rates increase due to market forces. However, this can be avoided if the ECB implements another TLTRO program. 

While a third round of TLTROs is expected, one needs to look at the program’s past structure along with the current economic situation to see how the program will likely be run. Many investors believe that, unlike past programs with a maturity time-frame of 48 months and lending rates that matched the deposit rate of negative 0.4 percent, a third generation of TLTRO is would last only 24 months. According to research from Pictet Wealth Management, 2016’s TLTRO contributed to an increase in inflation by 0.3 percent over 24 months.   

While the risk of deflation is not as bad as it was in 2016, there’s still a noticeable risk for it to reoccur. Some investors believe the ECB might make the TLTRO a permanent program that creates a sliding interest rate that mirrors the ECB’s Main Refinancing Operation. With a variable rate, those in the ECB would have an option to increase rates in the future.

There are a few different schools of thought that offer insight into the ECB’s take on interest rates. With the last iterations of the ECB’s TLTRO loan program, the TLTRO II round is set to be in full swing by the middle of 2020. It will need to have made an action plan for liquidity contingencies as the TLTROs begin maturing during this time frame.       

If banks are put up against a wall, reducing their ability to provide loans, it can put pressure on Europe’s growing economic development and keep the ECB more involved, thus extending this type of economic stimulation program. As President Mario Draghi of the ECB explained, the EU-wide bank sub-zero deposit rate continues to affect the loan makers’ ability to make money.

Additionally, the ECB reported an increase in loan requests in the third quarter. During the same period, banks softened credit standards for businesses and mortgages.

While a third round of TLTROs may be necessary to maintain liquidity, another round of ECB loans will indicate to some that Europe’s economy has a long way to go to emerge from instability.