Draghi Bank Lure Ties ECB Rate Insurance to Risky Lending

Photographer: Martin Leissl/Bloomberg

ECB President Mario Draghi reacts whilst speaking during a news conference where he unveiled historic measures to face down inflation, in Frankfurt today. Close

ECB President Mario Draghi reacts whilst speaking during a news conference where he... Read More

Close
Open
Photographer: Martin Leissl/Bloomberg

ECB President Mario Draghi reacts whilst speaking during a news conference where he unveiled historic measures to face down inflation, in Frankfurt today.

Mario Draghi is offering banks a risky form of insurance.

The targeted long-term liquidity plan that the European Central Bank president unveiled today allows lenders to hedge against the possibility that interest rates will rise over the next four years. In return, they must boost loans to companies and so take the risk that businesses in countries with weak demand can’t repay the debt.

“As a bank, you are getting out of this an insurance against rate hikes in year three or four,” said Richard Barwell, senior European economist at Royal Bank of Scotland Group Plc in London. “At the same time, you’re asking banks to take on credit risk. You have to believe there’s massive pent-up demand for credit to do that.”

Draghi is trying to jump-start lending that is still lackluser a year after the 18-nation euro area emerged from its longest-ever recession. His liquidity plan, dubbed TLTRO, makes funding of as much as 400 billion euros ($545 billion) available at today’s ultra-low rates.

The program comes against a backdrop of low inflation, mediocre economic growth and a bank balance-sheet review that reduces the incentive for euro-area banks to boost credit. While an ECB survey showed conditions for new loans stabilized in the first quarter, lending to companies and households has barely budged in 2014 and is down almost 2 percent from a year ago.

Four-Year Loans

The ECB’s plan has similarities to the Funding for Lending Scheme adopted from 2012 by the Bank of England. Financial institutions will be able to borrow money equivalent to as much as 7 percent of their outstanding loans to companies and households, excluding mortgages.

The TLTROs will have maturities of up to four years and be priced at the ECB’s benchmark rate at the time they are issued, plus 0.1 percentage point. From March 2015 to June 2016, banks will be able to borrow as much as three times the amount of their net lending to euro-area companies, above a threshold set by the ECB.

European bank stocks rose. Shares in UniCredit SpA, Italy’s largest bank, Spain’s Banco Sabadell SA and National Bank of Greece SA all surged at least 5 percent.

Weak Omens

The TLTRO represents “cheap funding, so the banks will take it up,” said David Owen, chief euro-area economist at Jefferies International Ltd. in London. “If the banks want to get lending going forward, the omens are not nearly so good. If you look at the example of the U.K., here loans are still contracting to non-financial corporations, even with cheaper funding.”

BOE data shows lending to non-financial businesses fell by 4.1 percent in the 12 months to April and credit to small and medium-sized enterprises slid 3 percent.

Draghi said officials will step-up their monitoring activities to make sure euro-area banks lend the cash rather than loading up on government debt with a lower risk of default. Banks that don’t lend the money on will be obliged to repay it after two years.

In its last round of long-term loans in 2011 and 2012, as a funding crunch in the financial system loomed, the ECB injected about 1 trillion euros without conditions. Some banks used the funds to conduct a carry trade, using the cash to buy higher-yielding bonds.

Negative Rate

The ECB wants to “make sure that this credit-enhancing measure is actually going to be used to lend to the real economy,” Draghi said today. The ECB also cut its benchmark interest rate and took the historic step of introducing a negative deposit rate, meaning it’ll charge banks that keep their excess cash at the ECB.

Even so, persuading banks to lend into economies that are still reducing debt and suffering from recession may be a tough sell. The value of defaulted loans in Spain has almost doubled since 2010 to total 193 million euros in March, according to Bank of Spain data.

The incentive to take up the TLTRO loan now would increase if banks believed borrowing costs will rise over the term of the loan. In a sign of that possibility, the ECB tweaked its communication on the future path of interest rates to remove a pledge to maintain a downward bias.

Bank Review

Official rates “will remain at present levels for an extended period of time,” Draghi said. He previously promised that rates will stay at “present or lower” levels.

The sluggish market for bank loans in Europe is also partly due to the ongoing review of bank balance sheets being conducted by the supervisory arm of the ECB. The unprecedented Comprehensive Assessment, coupled with tougher minimum capital requirements, is giving lenders pause for thought.

Draghi acknowledged that when he said that “banks should take full advantage of this exercise to improve their capital and solvency positions.”

With the ECB’s main refinancing rate now at a record low of 0.15 percent and the euro-area economy expanding, albeit slowly, the TLTRO still means that for a small premium banks can boost their profitability by locking in low funding costs as they expand lending.

“It has the incentives there,” said Sarah Hewin, head of research at Standard Chartered Plc in London. “The fact that you can triple up on your net lending if you are lending to corporates is an incentive, so it ought to have an impact.”

To contact the reporters on this story: Jeff Black in Frankfurt at jblack25@bloomberg.net; Emma Charlton in London at echarlton1@bloomberg.net; Alessandro Speciale in Frankfurt at aspeciale@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net Paul Gordon, Zoe Schneeweiss

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.