Here’s a look at the European Central Bank’s “toolbox”, which has been expanded over the past 15 years in response to the global financial crisis of 2008, the ensuing euro zone debt crisis and the COVID-19 pandemic.
EMERGENCY LOANS
The central banks of the 20 countries that share the euro can grant Emergency Liquidity Assistance to their lenders, with the ECB’s approval only needed above a certain threshold.
The big advantage of ELA over other forms of central bank funding is the broader range of collateral acceptable against the loans, including junk bonds, which helped Greek banks during their 2015 crisis.
A central bank needs the ECB’s approval if it wants to provide ELA for more than a year.
LONG-TERM LOANS
The ECB can reactivate its Targeted Longer-Term Refinancing Operations (TLTRO), offering banks multi-year loans at low interest rates.
This would mark something of a U-turn for the ECB, which is phasing out this cheap funding as part of efforts to fight inflation by raising borrowing costs.
Banks continued repaying their existing loans last week despite the Credit Suisse crisis.
The TLTRO requires banks to post higher quality collateral or take a hit on its value, which could prove a constraint in times of crisis.
BOND PURCHASES
The ECB’s instrument of choice – along with most other major central banks – for nearly a decade when it needed to steady financial markets.
But the ECB has also been reducing this form of money printing to raise the cost of credit. Stepping up purchases now would run counter to the fight against inflation.
The ECB has a number of bond-buying schemes.
If a full-blown banking crisis revives a doom loop between lenders and the governments that need to bail them out, the most suitable schemes may be the Transmission Protection Instrument and Outright Monetary Transactions (OMT), both of which are untested.
Announced last summer, the TPI allows the ECB to buy unlimited amounts of a country’s bonds if it feels it is being unjustly punished by the market and the turmoil risks disrupting euro area monetary policy.
OMT requires the country in distress to sign up for a bailout from the European Union. Unveiled at the height of the euro zone financial crisis by then ECB President Mario Draghi, the scheme quashed speculation of a break-up of the currency bloc but never came close to being used.
Source: Economy - investing.com
