By Valentina Magri

Mario Draghi ECB

Lowered rates were expected, but Mario Draghi made them real.

On 5th June 2014, the European Central Bank (ECB) set a 0.15 per cent intervention rate and a minus 0.1 per cent rate on banks’ deposits. But this time, the ECB has taken also unconventional measures to address deflation and credit crunch. One of them, labelled as TLTRO, is “copied from the Bank of England’s Funding for Lending Scheme”, as Martin Wolf wrote on the “Financial Times”. But before explaining the new weapon of Mr Draghi, it is worth having a look to the Funding for Lending scheme (FLS).

How does the FLS work?

The FLS was launched by the Bank of England (BoE) on 13 July 2012. Its goal was to incentivize banks and building societies to boost their lending to the English real economy. The central bank and HM Treasury extended the programme on 24 April 2013 by one year in order to allow participants to borrow from the FLS until January 2015 and to provide incentives to boost lending towards skewed small and medium-sized enterprises from January 2014. The FLS was changed again on 28 November 2013, with incentives to household lending removed in an attempt to focus the scheme on businesses, affected by credit crunch.

Has it worked?

Looking at usage and lending data regarding this year, published by the BoE on 29 May 2014, aggregate net lending to private non-financial corporations (PNFCs) fell in the first quarter of 2014. The majority of the fall was due to a continued decline in lending to companies by the commercial real estate sector. Moreover, also net lending to businesses fell by £2.7 billion.

The decline affects especially large companies, while SMEs suffers from “only” a £0.7 billion fall. The good news is that thanks to the FLS extension of April 2013, participants to the scheme enjoyed additional borrowing allowances for positive net lending to business from January 2014 to December 2014. In the “Inflation Report” of May 2014, the BoE provides a brief balance of the scheme. The officers of the central bank are satisfied with participation in scheme and with the fall in marginal retail, wholesale funding and spread indicator for households. But drawings from the FLS, mortgage approvals and net lending missed expectations. Evidentially, the FLS has not been completely effective so far.

How does the TLTRO work?

TLTRO stands for “Targeted Long Term Refinancing Operations”. In practice, the ECB’s counterparties will enjoy the opportunity of borrowing up to three times their net lending to non-financial private sector, except mortgages. The initial entitlement will be equal to €400 billions. The interest rates on TLTRO will be very low, namely equal at the rate of refinancing operations (MROs) prevailing at the time of the take-up, plus a spread of ten basis points. TLTROs will mature in September 2018. Moreover, the ECB announced a revamping of ABS. But they must be simple and real (that is: related to loans to the real economy) and transparent.

Will it work?

Both the FLS and the TLTRO share limit: they target directly banks and indirectly businesses. That it why many economists are suggesting that the best way to avoid a Japanese-style deflation in the Euro zone would be the Quantitative Easing (QE). This unconventional measure, adopted by the BoE in the UK and by the Fed in the US, injects money directly into the economy in order to boost demand. It achieves this goal thanks to the purchase of financial assets, such as shares and corporate bonds.

QE is still on the table as a future option for the Euro zone. In Mr Draghi’s words: “We are not finished here”.

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