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Benoît Cœuré Defends “Non-Standard” Refinancing Operations of the ECB

Benoît Cœuré, member of the executive board of the European Central Bank

Benoît Cœuré, a member of the executive board of the European Central Bank, today defended the refinancing of European banks in December and March. The French economist was speaking in Paris to the Association Française des Tresoriers d’Entreprises when he explained the necessity of the recent three-year deals:

“…The injection of long-term liquidity has helped to avoid a sudden curtailment of financing to the private sector by alleviating funding pressures on the banking system.”

According to the Bank Lending Survey in the fourth quarter of 2011, credit from most European banks to “non-financial corporations and loans to households, and to a lesser extent for loans for consumer credit” had been severely curtailed owing to problems on both the supply side and demand side.

Cœuré succinctly detailed the limited options for European banks in the current economic climate:

“Banks typically have three ways to adjust to pressures on their funding and capital positions: they can sell assets, raise capital or reduce lending. Let’s look at each of these options in turn.

“In an environment of extreme uncertainty and high risk aversion, risky assets can only be disposed of at very low prices, possibly considerably below their book value. Fire sales would weigh on profits, further deteriorating banks’ capital positions, generating in the process negative externalities and sub-optimal collective behaviour. Therefore, to be successful, significant reductions on the assets side of the banks’ balance sheet require a stabilisation of the economic and financial environment.

“Raising capital is also challenging in an unstable environment. Uncertainty about the pricing of the risky assets and the overall risk surrounding the valuation of banks makes it particularly difficult to attract new equity investors. Raising capital in such circumstances may not be accepted by shareholders as it may send a negative signal to the markets and lead to a drop in share prices. And, compared to 2008-2009, credible government support for banks’ capital positions was less available.

“This left banks with the third option, namely, to reduce lending. Banks could easily stop rolling over their loans or granting new ones. This strategy, however, while optimal from an individual bank’s perspective, would lead, if pursued collectively, to a credit crunch, with significant negative consequences on the real economy and additional strains on the banking sector.”

Most employment and employment generation in Europe relies upon small and medium enterprises (SME’s) and it is precisely these firms who rely more heavily upon lines of credit from banks than their larger competitors. The fear of a self-sustaining spiral of low economic activity led to a “non-standard” policy being devised by the ECB.

Two longer-term refinancing operations (LTRO’s) and a loosening in collateral rules eased the situation for banks, who bid in their hundreds for the packages. 523 bid in the first LTRO tender and 800 bid in the second. The measures were proclaimed a success in that financing conditions eased somewhat although credit for SME’s might still be some way off: “While banks seem to have used the funds obtained from the first three-year LTRO mainly for refinancing purposes, when looking forward to the next six months, they now seem to expect a stronger use of these funds for granting loans. Whether these expectations will materialise remains an open question and the Governing Council will closely monitor these developments.”

Downplaying the €3 trillion balance sheet of the Eurosystem, Cœuré said that the intervention of the ECB is within reasonable relation to the assets of the Euro area and still less than that of comparable lenders: “in early March, the ratio of monetary policy instruments to regional GDP was 15% for the Eurosystem, 19% for the Federal Reserve System and 21% for the Bank of England”.

Cœuré underlined that even with the measures, banks and government would need to continue with consolidation and structural reform to “improve their funding profile”.

In charting the future solutions to challenges facing the EMU, Cœuré mentions closer financial union as well as technical, legal and political advances in allowing the flow of the Euro among the 17 members states:

“Payments are at the very heart of a corporate’s activity and I am not sure that they always get the attention they deserve. Nowadays, more than 50% of the trade of the 27 EU countries takes place within the EU – and that trade is mainly based on cashless payments. With the introduction of the single currency there could no longer be any differentiation between national and cross-border euro payments: they should all be “domestic”. The Single Euro Payments Area project, in short “SEPA”, came to fill this void; its aim is to establish a single market for retail cashless euro payments by overcoming technical, legal and market barriers, so that people can make euro payments throughout Europe as easily, securely and efficiently as within their own countries.”

Streamlining the flow of Euros throughout the Eurozone will no doubt be music to the ears of retailers and businesses, heralding the prospect of greater trade and new markets. The abilities of the ECB board to chart a course toward closer fiscal union and a more integrated trading zone will therefore be very much under scrutiny.

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Editors and staff from the News Desk at The Global Herald.

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