Portal to the Economy of the Euro

MONEY and INTEREST RATES

This sections reviews the monetary policy of the ECB and various financial variables in the euro zone.

Next Governing Council meeting 8 March. A rate cut is a small possibility. Currently ECB is giving priority to flooding banks with liquidity. It is still restraining its bond purchases under Securities Market Programme (SMP).

At 9 Feb'11 Governing Council meeting President Draghi saw tentative signs of economic stabilisation and some easing of tensions in money markets. He expects growth to gradually recover later this year. Inflation is to fall below the ECB's target later this year. He maintained that a credit crunch had been avoided by the granting 3-yr loans. No new measures.

On 21 Dec'11 ECB provided EUR489bn in 3-yr loans to euro zone banks at 1%, boosting liquidity by much more than expected and effectively ending liquidity squeeze. It may also reduce the pressure on banks to deleverage to meet capital requirements.

The ECB sees this as its "big bazooka". Of the EUR489bn, EUR296bn was accounted for by maturing loans (as banks shifted shorter term borrowing into 3-yr borrowing), EUR193bn was "new" money. A second round of unlimited 3-yr loans will be offered on 28 Feb'12. Reportedly banks intend to borrow significantly more funds from the ECB then.

Cash may be used by banks to buy government bonds (carry trade), an indirect form of quantitative easing. But so far reports indicate that most banks keen to reduce their exposure to sovereign debt.

Collateral rules were further eased, allowing credit claims to be used (e.g. loans to small business). This is to encourage bank lending as well as to facilitate borrowing by smaller banks from the ECB. National central banks will bear the risk.

The 3-yr loans have soothed markets, eliminating for now the risk of a systemic banking crisis. Some euro zone banks have reportedly covered their funding needs for 2012. But money supply and bank lending is shrinking.

On 8 Dec'11 the European Banking Authority ordered European banks to raise EUR115bn of new capital.

Financial indicators:

8 Dec'11: Major injection of liquidity into banking system announced by ECB, rates cut by 25 b.p. more

Dollar swap lines extended to 1 Feb'13 to provide dollar liquidity to euro zone banks. more

ECB balance sheet shot up in Dec'11 as ECB lends more to banks, declined modestly since. more

Money supply growth turned negative. Three successive declines (Oct, Nov, Dec). more

Bank lending to private sector declines sharply. more

EURIBOR falling to close to 1%. more

Interest rates charged by banks easing. more

Governing Council meeting of 12 Jan'12 and 9 Feb'12: no new measures

Governing Council meeting of 8 Dec'11: rates cut again, 3-yr loans

The main refinance rate was again cut by 25 b.p. and two 3-yr refinance operations were announced under the fixed rate tender with full allotment procedure, meaning that banks can borrow unlimited funds at 1% for 3 years.

To further counter liquidity shortages in banking system collateral requirements were eased to allow the use of more asset backed securities. To further boost liquidity the deposits which banks are required to hold at their central banks have been reduced to 1% (from 2%).

Governing Council meeting of 3 Nov'11: rates cut

The first rate setting meeting under new President Draghi brought an unexpected 25 b.p. interest rate cut, justified by weakening growth and prospects of a mild recession. Draghi expressed confidence that inflation would decline below 2% early next year.

Governing Council meeting of 6 Oct: showering banks with liquidity

Against the background of severe market tensions the ECB announced unlimited 12-month loans to be offered in Nov and unlimited 13-month loans to be offered in Dec (thus repayment Jan'13). This in addition to the unlimited weekly, monthly and 3-monthly loans which will continue to be provided at least to mid-2012. In addition the ECB is to buy EUR40bn covered bonds in the market. After an apparently lively debate the main refinance rate was maintained at 1.5%.

Major dollar swap lines put in place 14 Sep'11

As the sovereign debt crisis threatened to spill over to euro zone's banks the ECB set up swap lines with the other major central banks to provide dollar liquidity to banks unable to cover their requirements in the interbank market. Banks in Europe partially fund themselves with USD. American money market funds and other institutions became reluctant to lend to some euro zone banks which are major holders of the bonds of the over indebted euro zone countries.

The ECB is conducting three dollar liquidity providing operations of 3-mnth maturity to ensure that euro zone banks have enough USD for the period to year end. See also below.

Governing Council meeting of 8 Sep'11: expectations of rate cut boosted

This meeting was held against a background of rising fears of a global recession and ongoing tensions in the financial markets as the euro zone's sovereign debt crisis continued to weigh heavily. The Governing Council acknowledged the slowdown in growth and the risk of a recession. At the same time it downgraded the risk to inflation. The dovish tone heightened expectations that interest rates may be reduced in the autumn.

Governing Council meeting of 4 Aug'11: liquidity boosted

This meeting was held with severe tensions in the financial markets as the debt crisis spread to Italy and Spain with the bonds of these countries in particular coming under intense selling pressure.

The ECB responded with emergency measures boosting liquidity. Banks were offered one 6-month loan (10 Aug'11 to 1 Mar'12), three 3-month loans in addition to its regular Main Refinance Operations, all under the fixed rate tender with full allotment procedure, meaning that banks can borrow unlimited funds.

The ECB also resumed its bond purchase programme SMP, after being out of the market for 18 weeks. In an effort to calm markets the ECB subsequently extended its purchases to Italian and Spanish government bonds after these two countries undertook to tighten fiscal policy further and accelerate structural improvements. The move was opposed by the Bundesbank and, reportedly, by three other Governing Council members.

Rate hiked to 1.5%

In two previous Council meetings (April and July) the ECB raised its main refinance rate each time by 25 basis points to reach 1.5% (chart below). The rate rises aimed to demonstrate the ECB's concern about inflation being above target. At the time growth prospects were positive.

Standard and non-standard monetary measures

The ECB makes a distinction between "standard" monetary measures, which concern interest rates and are designed to deliver price stability, and "non-standard" measures, which concern liquidity provision to the banking system to ensure that the (in the words of the ECB) "monetary policy transmission mechanism functions correctly", i.e. to alleviate the sovereign debt crisis.

It was repeatedly stressed that the persistence of the sovereign debt crisis would not prevent the ECB from raising interest rates if required to contain inflation.

Phasing out the extraordinary measures

The ECB remains keen to phase out the extraordinary measures in force to support the banking system. The ECB regularly expresses concern that some banks continue to be so heavily dependent on borrowing from it.

The intention still is to return to standard operating procedures sometime in the foreseeable future. The ECB will then again conduct its refinancing operations through the variable rate tender system, with the ECB deciding on the amount of liquidity provided and the market setting the interest rate. A long period of calm in the financial markets will be required before such a move can be undertaken.

A rejuvenated Governing Council:

Over one third of the 23 member Governing Council is being replaced this year, mostly by younger persons who often expressed hawkish opinions about the conduct of monetary policy.

President Trichet (69) retired end Oct'11, replaced by Italy's Mario Draghi (63). He may wish to burnish his anti-inflation credentials, coming from a country with a past of high inflation and deep budget deficits. But he takes over the presidency at a particularly embrangled time and has so far struck a more pragmatic note than his predecessor.

New Bundesbank President Jens Weidman (43) is pursuing the same anti-inflationary path as his predecessor and mentor Axel Weber (54).

Belgium's new central bank governor, Luc Coene (64), has in interviews struck a more hawkish tone than his predecessor Guy Quaden (66). Other changes among the central bank governors are Josef Bonnici taking over from Michael Bonello (Malta) and in Netherlands Klaas Knot (44) has taken over from Nout Wellink (67). Estonia's Andres Lipstok (54) joined the Council in Jan'11.

On the ECB's Executive Board Belgium's Peter Praet (62) replaced Gertrude Tumpel-Gugerell (59). Lorenzo Bini Smaghi (55) retired early to make way for a representative from France, Benoit Coeure (42).

Jurgen Stark (64), reputedly the most hawkish member, announced his resignation 8 Sep'11 because of opposition to ECB's bond buying programme. He is succeeded by Jorg Amussen (45), formerly state secretary at the German finance ministry.

Background: in crisis ECB lender of first and only resort

During the worst of the 2008 financial crisis, when there was no lending between banks (interbank lending being unsecured), banks dealt with the central bank: they borrowed from the ECB and deposited record amounts of cash with it.

Trading with the central bank replaced interbank trading. Rather than the lender of last resort, the ECB became lender of first and only resort. This accounted for the steep rise in the ECB's balance sheet in Q4'08.

This diminished in the early months of 2009 as liquidity gradually began to flow back from the ECB to the money market. In mid-Jun'09 refinance operations amounted to EUR611bn, down from a peak of more than EUR840bn at the turn of the year. The deposit facility declined over the same period from more than EUR300bn to EUR11bn.

Following a massive liquidity injections on 24 Jun'09 the ECB's balance sheet total again shot up to EUR1 997bn on 26 Jun'09 (from EUR1 719bn in prior week), just below the peak of EUR2 089bn at the start of 2009.

Refinance operations reached a new record of EUR897bn. Initially much of this money (EUR316bn) flowed back to the ECB in the form of deposits. Net lending to credit institutions thus amounted to EUR581bn.

Subsequently the balance sheet total shrunk again as the financial crisis abated and the ECB made a tentative start to normalise the situation.

The financial stress caused by the escalating Greek debt crisis, however, led to the renewed expansion of the ECB's balance sheet. Refinance operations rose and banks again deposited large sums with the ECB. Bond purchases by the ECB started in May'10 and added to the uptrend in the balance sheet.

Many smaller banks in the countries hardest hit by the sovereign debt crisis were shut out of the interbank money market and were again fully reliant on the ECB for their liquidity requirements. In Jun'10 the ECB's balance sheet reached a new peak.

Early in 2011 the balance sheet shrunk as the last of the long term loans were repaid. But as the debt crisis worsened again after mid-year the balance sheet again rose rapidly as the banks borrowed more from the ECB.

(In Dec'10 the ECB saw itself forced to double its capital to protect it from potential losses on the securities it holds in refinance operations and the securities it buys outright in the markets.)

The growth in the money supply is turning down after brief upturn in summer. The broad money supply M3 rose by 1.6% in the year to Dec'11, down from 2.0% in the prior month and 2.6% in the month before that.

On a m/m basis (s.a.) M3 declined by EUR51bn, the third successive month of decline. After a long period of modest monthly movements, the underlying trend turned upwards in the summer, only to turn down again in Oct-Dec'11.

The growth in the narrow monetary aggregate M1 remains modest. In the year to Dec'11 the rise in M1 came to 1.6% (down from 4.4% in the year to Dec'10).

In Dec'11 loans to the private sector rose by 1.0% on the year (adjusted for securitisation the rise was somewhat faster at 1.2%). On the month they declined by EUR76bn, after declining by EUR15bn in previous month (adjusted for sales & securitisation loans declined by EUR74bn, after declining by EUR14bn). (details below).

Some background:

It may be noted that virtually throughout the euro zone first ten years its broad M3 money supply grew faster than its reference value ("target"), accumulating liquidity on the way. The ECB considers that "excess" monetary balances were built up. It considers that M3 growth would have been stronger in the recent recovery phase were it not dampened by the unwinding of accumulated liquidity.

According to anecdotal evidence companies held unusually large amounts of cash during the recession.

The granting of bank loans to the private sector slumped at the end of 2011, after moving sideways for much of the year.

(The chart above shows loans as 3-month averages, to iron out the most erratic monthly fluctuations.)

Loans to households were being granted at a steady rate averaging EUR12bn per month in 2010 and in H1'11. A steep decline followed in H2'11.

The loans granted to households were almost entirely for house purchases, not for consumer credit. Banks prefer to lend for house purchases as the risk is lower.

Loans to non-financial corporations, the other "real" sector, have been erratic and mostly lagged behind loans to households. The ECB's earlier massive injections of liquidity into the banking system thus brought little (net) lending by the banks to non-financial companies.

In 2010 loans to non-financial companies averaged -EUR2bn per month. In Jan-Nov'11 they averaged EUR9bn, followed by a EUR37bn net repayment in Dec'11.

Loans to financial companies: earlier many of the loans still went to financial companies (mostly investment companies, including private equity firms and hedge funds) rather than the "real sector" (households and non-financial corporations).

Bank lending survey: The ECB’s Jan'12 quarterly bank lending survey (published 1 Feb'12) showed that banks' lending standards were tightened considerately further in Q4'11 and lending rates were raised. This was due to a deterioration in banks' access to wholesale funding as well as the more sombre economic outlook, the sovereign debt crisis and the impact of new regulatory requirements.

The tightening applied to lending to both enterprises and to households, though enterprises were hardest hit. Banks expect to tighten lending standards even further in Q1'12. Tightening was widespread across the euro zone with the exception of Germany.

The demand for loans also declined. Banks reported a steep decline in firms' financing needs for investment. The demand for consumer credit and housing declined further in Q4'11. A further decline in housing loans is anticipated for Q1'12.

The next Bank Lending Survey is due 25 Apr'12.

Bypassing the banks: Reportedly many companies were flush with cash in 2009-10 and did not need to borrow. This is in part a consequence of the extraordinary situation late in 2008 when the money markets ceased to function, depriving companies of liquidity. As a precaution companies raised their cash reserves by cutting costs, investments and personnel.

As a consequence of the prohibitive costs and onerous conditions of obtaining bank loans, companies also had greater recourse to the equity and bond markets. Reportedly they found it increasingly easy to raise large sums. Even high-yield bond issues again found buyers in H1'11. Conditions deteriorated in H2'11. There are also reports of firms borrowing directly from insurance companies and pension funds with banks merely acting as an agent.

Some background: bank loans to private sector

In the euro zone, unlike in the US, bank loans are the most imported source of external financing. Of these 48% typically go to households (3/5 for house purchases, 2/5 for consumer credit and other) and 44% go to non-financial corporations. This can be viewed as the "real" sector of the economy.

The remaining 8% go to financial companies (insurance companies, pension funds and other financial intermediaries other than banks).

In the first phase of the acute financial crisis (after the collapse of Lehman Brothers) bank lending to non-financial corporations expanded rapidly as firms drew down available credit lines, fearing that bank loans would be hard to obtain.

In a second phase lending declined sharply as demand for loans collapsed while at the same time banks anyway found it difficult to access finance and strived to reduce their balance sheets.

The ECB had hoped that through its massive liquidity injections it had created scope for the banks to raise lending to companies and households. The ECB believes that this "enhanced credit support" was the most appropriate way of promoting a recovery because of the greater reliance of business in the euro area on bank financing (in contrast to Anglo-Saxon countries).

According to the ECB banks account for 70% of company financing in the euro area, compared to only 20% in the US where companies issue commercial paper and corporate bonds to finance the majority of investments.

In spite of the massive liquidity injections lending continued to spiral downward. The decline would probably have been much more severe in the absence of the ECB measures. Constrained by inadequate capital and restrained access to finance as well as burdened by impaired securities on their books, banks became particularly risk adverse, inclined to reduce rather than expand lending.

The decline in bank lending was also in part due to companies requiring less working capital as the recession deepened. Subsequently, as banks' lending criteria tightened substantially, companies increasingly resorted to stock and bond markets to secure capital. Moreover companies hoarded internally generated cash.

The decline in loans to households was led by a slump in lending for house purchases as the housing boom collapsed in a number of countries. Housing loans were also the first to recover and grew at a sustained rate in 2010. Banks favour these as safer. Housing loans can be collateralised and used to back covered bonds. Consumer credit, seen as more risky, remains in decline.

In the past bank loans to non-financial corporations have typically recovered one year after the upturn in the economy. If repeated in the current cycle they should have turned up in Q3'10. They did, but the rise was not sustained in Q4'10.

The failure of bank lending to recover fully may be due to both demand and supply factors. Bank lending surveys indicate that demand for bank loans from enterprises remains restrained while the banks have imposed increasingly severe lending standards.

Fragile banks: hard hit by sovereign debt crisis

The euro zone's banks emerged from the 2008-09 recession fragile and undercapitalised. Whereas America's banking system was restructured and recapitalised in 2009, little was done in Europe. Because of how the banks are embedded in the financial and political structures of their home countries change is proving difficult.

The sovereign debt crisis is proving particularly hazardous for the euro zone banks because of their substantial holdings of the debt of the over indebted countries. The large size of banks' holdings was encouraged by their zero risk rating in regulatory capital calculations. Also the ECB accepts sovereign bonds with no haircuts as collateral for the provision of liquidity.

The capital of most euro zone banks would be inadequate if their portfolios of foreign debt were valued at market prices. This makes a restructuring of, for instance, Greek debt problematic. As banks find it difficult to obtain capital in the markets or sell unsecured bonds, they may have to be recapitalised by public funds, itself problematic. One way to boost their capital ratios would be to stop lending. This would in turn undermine growth.

For detailed discussion see: Nicolas Veron, Testimony on the European Debt
and Financial Crisis, Bruegel Policy Contribution, September 2011

Recapitalisation of European banks would require EUR100bn to EUR200bn. France calls for the EFSF bailout fund to provide the funds. Germany is calling for each country to recapitalise its own banks. A compromise is being sought.

8 Dec'11 the European Banking Authority ordered European banks to raise EUR115bn of new capital.

The 3-month EURIBOR was on an uptrend in H1'11 as the ECB gradually withdrew liquidity from the money markets and raised interest rates.

The rate rose above 1.5% after the ECB hiked its main refinancing rate to 1.5% in Jul'11. But from Aug'11, as the sovereign debt crisis intensified again and the ECB injected increasing amounts of liquidity into the banking system, the rate eased steadily.

Interbank lending is severely hampered by the debt crisis. Banks' holdings of the deteriorating debt of the deeply indebted euro zone governments are weighing on the interbank money market. Many banks remain dependent on the ECB for their liquidity needs, even have recourse to the ELA facility (see below).

USD LIBOR steadily inched towards 0.6%, from a mid-2011 low of 0.255%. The gap between euro zone and US money market rates shrank, one reason why the EUR has depreciated against the USD (the other reason being the deepening euro zone debt crisis). In week 1 of 2012 USD LIBOR reached a peak of 0.58%. Since the rate started to ease again.

The overnight EONIA rate, which remained low for most of 2010 was on a steep uptrend in H1'11. Since the rate has been on a declining trend as liquidity builds up in the system.

Some background: EURIBOR (Euro Interbank Offered Rate) is the (average) rate at which banks lend to each other in EUR in the euro zone. EURIBOR is tracked more widely than its London counterpart, the Euro LIBOR (London Interbank Offered Rate). EURIBOR is used as a benchmark rate for a wide range of assets and is the main gauge of unsecured interbank lending in euros.

The rate is a mix of interest rate expectations and of the willingness of banks to lend in the interbank market.

The rate plunged after the ECB drastically eased monetary policy in Oct'08. It reached its all-time low of 0.634% at the end of Mar'10. As the Greek debt crisis spread to other countries the rate rose steadily, reaching a peak of 0.905% early in Aug'10.

Initially the cost of borrowing in the interbank market rose as banks hesitated to lend to each other on concern that the financial health of some banks may be endangered by the sovereign debt crisis. Many European banks have a heavy exposure to the debt of Greece and other heavily indebted euro zone countries.

More recently reduced liquidity provided by the ECB has forced more banks to borrow in the interbank market. This pushed the EURIBOR higher. For instance the ECB's 1-year loan which expired 1 Jul'10, required banks to repay the EUR442bn they borrowed a year earlier. Liquidity in the euro zone became less ample.

As a result of the sovereign debt crisis many smaller banks in the countries hardest hit by the crisis have reportedly been shut out of the interbank money market and are entirely reliant on the ECB for their liquidity requirements. (Interbank lending is unsecured.)

EONIA (euro overnight index average): in 2009 the ECB's provision of unlimited liquidity to the financial system, through its fixed rate tenders, consistently pushed the EONIA rate significantly below the official ECB main refinance rate and towards the lower deposit rate, thereby breaking the normally close link between the EONIA rate and the ECB's main refinance rate (see above chart).

Background:
ECB's 10 May'10 measures: Policy moved back to stimulation
Enhanced capability of intervention in crises

A major shift in policy was announced Monday 10 May'10. During the previous week financial markets were increasingly unsettled by the euro zone's rapidly deepening sovereign debt crisis, ending the week in turmoil.

The debt problems of Greece spread to other deeply indebted euro zone countries, obliging the ECB to reverse its planned gradual withdrawal of unlimited cash support. Banks in Greece, Ireland, Spain and Portugal were heavily dependent on this facility and may have faced illiquidity should this source have dried up.

After the ECB left its policy stance unchanged at its 6 May'10 policy meeting, markets plunged, interbank lending started to freeze up and the financial situation risked moving out of control (similar to the aftermath of the Lehman Brothers bankruptcy). The ECB had to act. 10 May brought a dramatic volte-face. Policy was moved back to stimulatory.

Though initially viewed as disorderly, last gasp panic measures lacking unanimity, the ECB, by specifically granting itself the power to buy securities in the markets, became a credible purchaser of last resort for the securities of the governments in financial difficulties. This has greatly enhanced its ability to intervene in crises situation

Securities Markets Programme (SMP): private and public securities bought by the euro zone's central banks on behalf of the ECB in the markets ("quantitative easing"). The two German members on the Council opposed the measure.
Reportedly a number of national central banks already started buying government bonds in the markets on 10 May'10. In that week (week 19) bond purchases totalled EUR 16.5bn. Since weekly purchases have tailed off, though they briefly rose again after the Irish bail out. So far in 2011 the ECB has made virtually no additional purchases.

These purchases are "sterilised". ECB invites banks to deposit cash with it for one week periods (replacing overnight deposits with the ECB with one-week term deposits) to offset the rise in the money supply resulting from the bond purchases. This is little more than a symbolic move as the ECB continues to meet in full banks' demand for liquidity.
Hence the ECB claimed that monetary policy was "unchanged" and the measure did not constitute "quantitative easing". It stressed that the securities purchases were to address dysfunctional markets, not to assist the heavily indebted countries.
Unlimited liquidity provision: ECB reactivated its unlimited fixed rate liquidity provision to the banks with various maturities to ensure banks had access to funds during the crisis.
Liquidity swap lines: USD swap lines with US Federal Reserve reopened to provide ECB with as many USD as it requires for lending on to euro zone banks. Swap lines were also activated with other central banks and subsequently prolonged to 1 Aug'11.

Note 29 Jun'11: as part of measures to cope with potential Greek debt default dollar swap lines between major central banks have been extended to Aug'12

Note 30 Nov'11: in response to the deepening debt crisis and liquidity shortages swap lines between major central banks were reactivated and extended to 1 Feb'13. Federal Reserve also lowered rate it charges on dollar liquidity to 50 b.p. (from 100 b.p.)

Background swap lines: Through the swap arrangements, put in place in Dec'07, the US Federal Reserve offered dollars to foreign central banks in exchange for their currencies. They take the form of repurchase arrangements against suitable collateral. The dollars were then lent on in their domestic markets, enabling firms access to dollars at a time when the normal financial channels shut down. At the peak in Oct'08 European banks took USD170bn through this channel, mostly in order to repay dollar loans taken out when US interest rates were exceptionally low.

Background:
Emergency Liquidity Assistance (ELA): little known

The little known ELA facility allows national central banks (NCB) to provide funds to domestic financial institutions in financial difficulty over and above the liquidity provided by the ECB's regular refinancing operations. These operations are separate from the Eurosystem, but the ECB's Governing Council can with a ⅔ majority oppose the granting of further ELA, if, for instance, it considers the emergency assistance provided constitutes monetary financing.

The assistance provided is supposed to be temporary and to an illiquid but solvent financial institution. The lending is not subject to ECB collateral requirements. Thus a bank can present its NCB collateral which would not be acceptable by the ECB (but which would be acceptable by the NCB).

Some known examples of provision of ELA are by the National Bank of Belgium and the Bundesbank during the Sep-Oct 2008 financial crisis. The Central Bank of Ireland has provided ELA to some Irish financial institutions since 2009 and the amounts have grown substantially in the course of 2010. (see Buiter)

In Sep-Oct'11 Greek banks reportedly ran out of acceptable collateral and are resorting to the ELA facility to obtain liquidity from the Bank of Greece.

Background:
Intra-eurosystem lending: rising rapidly

Under the eurosystem TARGET2 payment system when a banking retail transaction results in a debt between banks located in different euro zone countries which is not cleared in the interbank market, the debt creates a claim between the respective national central banks (NCB).

If for example a company decides to move its deposit from an Irish bank to a German one (because of doubts about the Irish bank's solvency), and the German bank is unwilling to accept payment in the form of a claim on the Irish bank, the debt is settled via the respective NCBs. The Bundesbank acquires a claim on the Central Bank of Ireland (CBI). See Whittaker

The outstanding claims and liabilities of all national central banks are transferred to the ECB at the end of each business day, where they are netted out. The Bundesbank's claim against the CBI then becomes a claim against the ECB. The CBI's liability to the Bundesbank becomes a liability to the ECB.

As the sovereign debt crisis intensified deposits not only fled Irish banks, but also Greek, Portuguese, Italian and Spanish banks. Germany was the major recipient of these funds, followed at some distance by Luxembourg and Netherlands.

Besides the loss of deposits, the growth in eurosystem lending results from banks unable to refinance maturing debt and unable to access the interbank market. Also current account deficits not covered by capital inflows are financed in this way.

The banks which lose deposits or are unable to access the interbank market replenish their liquidity by borrowing from the ECB under the normal repo operations against collateral. Under the current full allotment system the ECB fully meets all demands for liquidity. Those banks lacking acceptable collateral may borrow from their NCB under ELA described above.

Note that the monetary base in the euro zone does not increase as the banks receiving the deposits make a corresponding reduction in their borrowing from the ECB.

Eurosystem lending has risen rapidly, amounting to EUR457bn end-2010 (up from EUR80bn end-2006). The major creditors end-2010 were the Bundesbank (EUR326bn), followed by the central banks of Luxembourg (EUR68bn) and Netherlands (EUR41bn). The major debtors were the central banks of Ireland (EUR146bn), Greece (EUR87bn), Portugal (EUR60bn) and Spain (EUR51bn). See Bundesbank p 34-35

Some commentators have viewed this as, for instance, Germany, through the Bundesbank, lending EUR325bn to other central banks in the eurosystem. And, for instance, the CBI borrowing EUR146bn from Germany to support its banks. All at the modest interest rate of 1% (up to Apr'11). In fact the lending is done by the ECB and if, say the CBI, defaulted the loss is born by the ECB (and ultimately by the NCB according to the ECB's capital key). See Storbeck

The imbalances in the eurosystem will decline once the sovereign debt crisis is resolved. The ECB has called on the governments of the indebted peripheral countries to recapitalise and restructure their banks so that they can return to the interbank market and reduce their reliance on ECB funds. But banks naturally have so far preferred the cheap and readily available funds from the ECB.

NOTE: TARGET stands for Trans-European Automated Real-Time Gross Settlement Express Transfer.

Background:
Monetary measures taken 2008-09 to counter the financial crisis and recession: no banks to fail, unlimited liquidity provided

ECB cut interest rates: the main refinancing rate of the ECB was cut seven times, bringing it down to 1% (from 4.25% pre-crisis). The ECB's deposit rate was cut to 0.25%.

Unlimited liquidity injections by the ECB: since 8 October 2008 full demands for refinancing were met at the fixed rate (“fixed rate tender procedure with full allotment”). Previously a fixed sum was made available for which banks put in bids. Three auctions were held where banks could borrow unlimited funds for up to 12 months at 1% (24 Jun'09, EUR442 demanded; 30 Sep'09, EUR75bn; 15 Dec'09, EUR97bn).

Qualitative easing: the standard of eligible collateral was lowered. Thus, to access ECB funds a greater range of securities could be presented by the banks as collateral.

Quantitative easing: as traditional expansionary monetary policies had little traction in the recessionary environment, the ECB agreed to buy EUR60bn of covered bonds in the markets for cash. This is a very modest sum, reflecting unease about quantitative easing, associated with "money creation", "monetising the debt" or "printing money", eventually leading to inflation or even hyper inflation. As a result the ECB shunned the term "quantitative easing", preferring "enhanced credit support"

Government rescues: the national authorities stepped in to bail out Fortis and Dexia, two Belgian banks, and Hypo Real Estate a German company. In Nov'09 the German government bailed out WestLB bank. A sum of EUR200bn was made available for governments to directly re-capitalise their banks. National authorities stepped in to guarantee savings.

Governments guarantee interbank lending: up to EUR1trillion was made available in the euro area to guarantee interbank lending with the aim to allow interbank lending to resume.

ECB Governing Council Meetings usually first Thursday in month in Frankfurt (other locations indicated) -
Q4 2011	Q1 2012	Q2 2012	Q3 2012	Q4 2012
6 October Berlin	12 January	4 April	5 July	4 Oct in Ljubljana
3 November	9 February	3 May in Madrid	2 August	8 November
8 December	8 March	6 June	6 September