What is the TLTRO and how is it different to LTRO

The ECB recently concluded its first round of TLTRO or targeted long term refinancing operations, which turned out to be anti-climatic. Against an estimated 150bn Euros up for grabs, banks managed to take only 82bn Euros in TLTRO loans from the ECB. The question that might come to one’s mind is what is the TLTRO and how is it different from the regular LTRO scheme that is well in place by the ECB.

The TLTRO was first announced at the ECB’s June 2014 monetary policy meeting where ECB Chief, Mario Draghi unveiled a slew of measures to tackle the high exchange rate and the threat of deflation in the Eurozone. Back then, the ECB allocated a total of €400bn Euros in targeted long term refinancing operations to ease up liquidity in the Eurozone banks.

How is TLTRO different to LTRO?

The TLTRO has been designed to work on the same principles of the BoE’s “funding for lending” scheme. Under this scheme, the Bank of England launched a funding process to help its banks to take loans from the BoE at low interest rates provided the banks were able to prove and show that they were lending money to their end customers. The Funding-for-lending or FLS for short seemed to work well for the BoE, which concluded this scheme earlier this year.

The TLTRO functions similarly where banks can take a loan up to their initial allowance, which is defined as up to 7% of the bank’s outstanding loans as of April 2014, to the Eurozone area in the non-financial private sector but excluding household mortgages.

The TLTRO loans have a 4-year maturity with a fixed interest rate equal to the Eurozone’s main refinancing operations rate at the time of taking the loan along with an additional fixed spread of 10bps. The TLTRO interest can be repaid in parts or arrears when the initial borrowing is repaid by the counter parties.

The TLTRO auction or borrowing scheme would allow the Eurozone banks to borrow money from the ECB until June 2016, spread over quarterly. Banks can start to repay the TLTRO loans after 24 months from borrowing.

Why is the TLTRO important and what is its impact on the Euro?

The TLTRO is important as it was specfically aimed to target ailing banks that have too many liabilities on their books. As investor funding tends to dry up, the ECB’s TLTRO was aimed to help bank clear their liquidity lines in hopes to restart their lending business.

The first round of TLTRO was conduction on September 18, which proved to be lackluster as 255 banks representing 1300 financial entities took loans worth €82bn as against an estimated €150bn. While some critics were quick to point to the larger weaknesses in the Eurozone’s banking system there was an equal amount of justification for the lack of willingness from the banks to borrow more citing factors such as the Scotland Independence vote to the bank stress tests due in October deterred most banks from taking up the TLTRO offer.

From the Euro currency’s point of view, the markets currently look at the first round of TLTRO’s as a precursor to a wider QE style program in the form of ABS (Asset Bank Securities) bond purchase program to be launched by the ECB. While the TLTRO is still too early to be ruled out, the December window will prove to be vital as it would have a wider implications on the markets. Critics and analysts alike do wonder though that banks hesitation to loan from the ECB is unlikely to change in the December TLTRO lending window as well.