Wednesday, February 15, 2012

The new LTRO will boost TARGET2 imbalances - Bank of Italy example

As the ECB gears up for the LTRO-II program, one of the issues they ought to keep in mind is the increase in TARGET2 imbalances it will cause. With this additional borrowing by the periphery and French banks via their national central banks (NCBs), the balance sheets of the NCBs will grow further.

Consider Italy for example. The Bank of Italy balance sheet has grown dramatically in the last 7 months with the bulk of the growth coming from loans to Italian banks. These include short and long term (LTRO) lending. Notice in the chart below that the 3-year LTRO replaced some of the short term funding in December. The total lending to Italian banks reached over €200bn at the end of 2011.

Bank of Italy lending to Italian banks  (€ MM)

On the liability side of the Bank of Italy balance sheet, the debt to the Eurosystem has grown at a similar rate, also approaching €200bn. This is effectively how loans to Italian banks have been financed since mid-2011.

Bank of Italy liabilities to the Eurosystem (€ MM)

Now, with ABS and even corporate loans permitted as collateral for LTRO financing, banks will tap the facility to the fullest (leaving no unencumbered assets on their own balance sheets.)
The ECB:  ... national central banks will be allowed, as a temporary solution, to accept as collateral additional performing credit claims (namely bank loans) that satisfy specific eligibility criteria. The responsibility entailed in the acceptance of such credit claims will be borne by the national central bank authorising their use. 
Therefore making these new LTRO funds available to banks will grow the NCBs balance sheets further, increasing their liabilities to the Eurosystem. The periphery NCBs in particular will build disproportionate amounts of such liabilities in order to provide more financing to banks in their countries.
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