FRANKFURT (Reuters) - The European Central Bank is expected to give banks fresh long-term loans known as TLTROs to keep credit flowing to companies in the euro zone, in the hope that an already marked economic downturn will not be exacerbated by a sudden crunch in lending.
WHAT ARE TLTROs?
The ECB gave banks a total of 739 billion euros of cash in four-year, "targeted longer-term refinancing operations" - or TLTROs - in 2016 and 2017. The "targeted" part of the name is key: As long as banks lent the money on to the real economy - companies, in particular - they could get cash back rather than pay interest on it, as the facility would be remunerated at the ECB's minus 0.4 percent deposit rate.
WHY ARE WE TALKING ABOUT THEM?
Once the remaining maturity of the previous loans falls below one year, only part of the money will count towards banks' net stable funding ratio (NSFR) so they will have a greater incentive from June to pay the loans back to the ECB. This would shrink the ECB's balance sheet while forcing banks to find more expensive funding and restricting their ability to loan.
Lending data already showed a big dip in corporate lending growth in January, in line with banks' tendency to lend more freely during booms and cut credit sharply during slowdowns. Banks' exceptionally weak profits are also expected to reinforce this so-called pro-cyclical behaviour.
As TLTROs mature in large chunks, the ECB fears a cliff-edge effect.
DO THEY WORK?
Growth in bank lending hit post-crisis highs last year, and ECB surveys show that funding is not among banks' top concerns, suggesting the TLTROs have worked their way through to the economy. The banks surveyed overwhelmingly said they had loaned the funds on to businesses and this had lowered their costs, allowing them to ease credit conditions.
WHAT IS THE ECB EXPECTED TO DO?
Having already discussed a new TLTRO, it is expected to commit to the facility as early as March 7 but may hold off on the final details until as late as June, just before the remaining maturity of the first chunk of old TLTROs fall below one year.
The terms and conditions of the loan will be key as they could lock the ECB into a policy stance for years.
HOW WILL THE NEW LOANS DIFFER FROM OLD ONES?
ECB chief economist Peter Praet described the old TLTROs as "very generous", which suggests the conditions could be less favourable next time round, although if the euro zone's downturn deepens, policymakers could opt to stay generous.
For one thing, the new loan is likely to be for a shorter period such as two or three years, rather than the previous four. It could also have a floating interest rate initially set at the ECB's main rate, which is currently zero.
If the cash is no longer "targeted", banks could use it as they see fit. The risk is that some would buy government bonds and cash in on the difference in interest rates, helping themselves but doing nothing for the rest of the economy. This type of "carry trade" has been seen in the past, and some policymakers have already expressed reservations about it.
Another issue is whether the ECB would simply roll over old TLTROs or let banks take new loans. It could also set limits on the amount banks can borrow.
WHAT'S THE CONTROVERSY?
Italian and Spanish banks hold 56 percent of the 724 billion euros still outstanding from previous TLTROs. Some policymakers say this suggests the facility is de facto directed at particular countries rather than the euro zone as a whole.
By contrast, banks in northern Europe with excess cash have to pay to park their funds overnight at the ECB.
As the current TLTRO loans are already an extension of a previous facility, some argue that banks are too reliant as it is on ECB funding and that a new loan will not do much to wean them off central bank cash.
Still, there is no indication that policymakers would oppose a new TLTRO, even if the exact details will be subject to lengthy debate.
(Reporting by Balazs Koranyi; Editing by Hugh Lawson)