New Articles | Refinancing banks in the euro zone

Not cheap enough

The European Central Bank's latest wheeze falls flat

WITH euro-zone inflation dipping to a record-breaking low of 0.4% last month, officials at the European Central Bank (ECB) have been scrambling to find ways to boost the economy. One way to do this is to encourage the currency area's banks to lend more. The ECB has already cut interest rates to just 0.05% to help do this, and on September 18th it started a programme of "targeted longer-term refinancing operations" (TLTRO). The scheme offers euro-zone banks cheap loans—at a fixed annual interest rate of 0.15% for up to four years—if banks pass on low borrowing costs to their customers. Yet early indications suggest that Mario Draghi, the president of the ECB, will be disappointedwith the results of the scheme.

In total the ECB hoped to lend €400 billion ($540 billion), equivalent to 4% of euro-zone GDP. But take-up of the first tranche of the scheme fell short of expectations: only €82 billion was allocated. While 382 financial institutions were eligible, just 255 took up funding.

Efforts to increase capital requirements in the euro-area have contributed to the lacklustre take-up of the scheme. Generally speaking, banks in the euro zone want to slim their balance sheets rather than expand them. Many are unwilling to lend more because of fears that this may make their balance sheets look worse in an asset-quality review due next month. Default rates on loans outstanding are still high: many medium-sized periphery banks have shied away from lending more, even with the offer of cheap ECB funding on the table.

Low business confidence has also depressed the desire of banks to lend. Geopolitical tensions, focused around the Ukraine crisis, have perturbed both borrowers and lenders. Stagnant growth figures have also dampened animal spirits. Germany, normally seen as the euro-area's economic powerhouse, saw its GDP fall by 0.2% in the second quarter of this year.

Many analysts are predicting that a second round of the scheme, due to be announced on December 9th, will prove to be more popular. There will be more rounds of funding in 2015 and 2016. This should be good news: take-up of TLTRO funding helps to push down on the euro, which has already fallen about 7% this year. That in turn should help boost stagnant export volumes as well as growth.

However, the most important question is whether TLTROs really do have any effect on lending to small- and medium-sized businesses, who have been starved of funding since the start of the crisis. Southern Europe stands to gain the most. Small firms are especially important there, as they account for 65% of value-added in the non-financial sector, against a euro-zone average of 58%.

But history is not on the ECB’s side. Similar schemes in the past—like the Bank of England’s funding-for-lending scheme—were far from perfect. In 2013 banks drew £40 billion ($67 billion) of such funds; but net lending to British small firms fell. The banks used the extra cash to shore up their own capital ratios rather than lend more to businesses.

In any case, the muted response to the offer of cheap funding puts extra pressure on the ECB. From October it will start to buy covered bonds and asset-backed securities (ABS). But the outstanding euro-zone ABS market is small (at around €100 billion) and the ECB plans to shy away from riskier assets. As a result, the ECB will find it tricky to buy more than €100 billion a year in ABS and covered bonds. To get the recovery going, a dollop of quantitative easing—involving purchases of sovereign debt—may be necessary. Unless that happens, Mr Draghi's crisis may drag on for some time.