Free exchange | The ECB's second funding offer

Thanks but no thanks

By P.W. | LONDON

SIX months ago, the European Central Bank made an offer that seemed too good to be true. As part of its policies to counter low growth and inflation in the euro zone, it would make available to banks funds lasting until 2018 at dirtcheap fixed rates. By the time of the first funding operation, in September, that rate was a mere 0.15% a year. In all, banks could borrow as much as €400 billion in the first two of the operations. The only stipulation was that they should improve their lending record to the private sector (which could mean their stock of loans to businesses declining at a slower pace).

Despite these generous terms, banks were chary about accepting the offer, borrowing only €83 billion in September. The low take-up has continued in the second operation held this week. The ECB revealed today that banks borrowed only €130 billion. In other words banks have helped themselves to little more than half the amount that was available this year.

This week’s lending operation does not end the offer. There will be six further tenders at quarterly intervals until mid-2016. But the terms on which the funding will be made available will be more onerous since banks will actually have to increase their net lending in order to be eligible. What this suggests is that the ECB will have to use other means than lending to banks in order to raise its balance-sheet by around €1 trillion ($1.25 trillion) as it now intends, the more so since there is continued downward pressure on its balance-sheet as banks repay around €250 billion that they still owe the ECB from its previous round of long-term lending (over three years) in the winter of 2011-12).

Already, the ECB has been buying private assets, in the shape of covered bonds (debt issued by banks that is backed by mortgage loans or lending to the public sector) and asset-backed securities. But the size of these markets is too small for this to make much impression. At the latest count the ECB had bought little more than €20 billion in such assets (overwhelmingly covered bonds) since it started in late October.

But if the central bank does want to raise its balance-sheet by around €1 trillion it will have to widen its purchases beyond these limited markets. Purchasing corporate bonds is one option, but that is also too small to allow sufficient traction. Only sovereign bonds provide a big enough market. And that will involve the ECB trampling over German sensibilities arising from their view that such purchases trespass on fiscal policy. The row this will create could undermine at least some of the good intentions of the policy.

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