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54 Deleveraging, What Deleveraging demand. The first LTRO, with a one-year term, was implemented in early 2009; a second wave was implemented in late 2011 to early 2012, with a three-year term. As a result, the balance sheet of the Eurosystem expanded meaningfully. Indeed, the expansion in that period is comparable with that of the Federal Reserve system resulting from quantitative easing. But, given the temporary nature of the LTROs and the option for banks to repay funds borrowed under the scheme, the ECB balance sheet started to shrink in 2012 in line with an easing of liquidity tensions and some banks repaying their loans. This removed excess liquidity in the system and put upward pressure on money market rates, effectively creating a monetary contraction. Although aggressive ECB action was essential to save the financial system from collapse, there are two critical problems. First, there is evidence that the first wave of LTROs, implemented in the midst of the liquidity crisis following the Lehman collapse, was successful in relation to both financial stability and monetary policy. 22 As the crisis deepened, however, it became clear that solvency problems of sovereigns and banks were at the core of the financial crisis. Given the lack of government action and the constraints on other forms of ECB intervention, the LTROs were likely instrumental in preventing a collapse of the banking system, but they were neither adequate to deal with the solvency problems of banks, nor sufficient to avoid a fully fledged credit crunch. Indeed, it can be argued that, in the absence of action to recapitalise the banks, one of the consequences of the LTROs was to keep insolvent banks alive, particularly in the euro periphery, and to delay the deleveraging of the banking sector. As shown above, financial debt remained almost constant in 2011-12. The LTROs did not prevent a credit crunch in the economy, as the funds they provided were used to buy government bonds rather than to lend to the economy, as shown by the increase of the ratio of sovereign bonds to assets in the Eurozone banks’ balance sheets (Figure 4.13). This change in asset composition, particularly strong in Spain and Italy, has been a significant feature of the Eurozone banks’ adjustment and has involved, in particular, domestic sovereign bonds (see, amongst others, Battistini et al., 2014). As a consequence, as argued by Reichlin (2014), lending in the second recession was weaker than in the first if we control for the fact that the decline in real economic activity had been less pronounced (see Figure 4.14). In sum, weak lending and a change in asset composition in favour of sovereign bonds are the result of a combination of factors: undercapitalisation in the banking sector; restrictive fiscal policy; geographical segmentation of financial markets leading to a high correlation between bank risk and sovereign risk; the ineffectiveness of monetary policy in this context; and persistent stagnation of the real economy. Progress has been made towards the establishment of the banking union which, together with the new European Systemic Risk Board, promises to lead to more timely action on banks in the future (although with much uncertainty related to the limited resources to be available for use in crisis resolution). 22 In a quantitative study, Giannone et al. (2012) have shown that the macroeconomic effect of these policies was small but significant.
Case studies 55 Figure 4.13 Breakdown of Eurozone banks’ assets 16 Loans (lhs) Government Bonds 6.0 16 (% of banks' total assets) 5.5 15 15 14 5.0 4.5 14 4.0 13 06 07 08 09 10 11 12 13 14 Source: Authors’ calculations based on ECB data. 3.5 Figure 4.14 Eurozone loans and industrial production EMU loan flows (6m ma; € bn) and IP level 55 50 45 40 35 30 25 20 15 10 5 0 -5 -10 -15 CEPR recessions Loans, Non-Fin. Corporations Loans Households IP (rhs) -20 01 02 03 04 05 06 07 08 09 10 11 12 13 14 116 114 112 110 108 106 104 102 100 98 96 94 92 90 Source: Authors’ calculations based on Eurostat and ECB data. Let us now come to the second problem. A new phase started in the second part of 2012. Given the temporary nature of the ECB LTRO programme and the option for banks to repay funds borrowed under that scheme, the Eurosystem balance sheet started to shrink. The contraction in the size of the Eurosystem balance sheet is striking if we compare it with the still ongoing expansion of the Federal
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Geneva Reports on the World Economy
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International Center for Monetary a
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International Center for Monetary a
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Acknowledgements We thank Susan Lun
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List of Conference Participants Edm
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List of Conference Participants xi
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List of Conference Participants xii
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Foreword Since 1999 the Geneva Repo
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2 Deleveraging, What Deleveraging 1
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References 105 Jorda, O., M. Schula
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It is widely accepted that high lev
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