Eleven years after its inception, the TLTRO has become so entrenched that it’s almost unimaginable that it will ever go. Although terms may tighten, some banks will have come to the conclusion that it will provide carte blanche three year funding that is materially discounted to market levels forever.
In its latest iteration, the TLTRO has provided an indiscriminate blanket of super-cheap liquidity to lenders, who only need to show that they have not reduced net lending. This implies that it is no longer that "targeted".
Illiquid credit claims, alongside a host of other more liquid securities, can be pledged in return for funding at minus 100bp. This can be returned straight back to the ECB with absolutely no credit risk for a tidy 50bp pick up or invested in zero risk government bonds for much more.
As a consequence, there’s been a fourfold surge in TLTRO drawings to €2.2tln since the end of 2019. European lenders that didn’t necessarily need the funding have been able to boost their combined income by a whopping €20bn, according to Moody’s.
But the profit boost has made it more challenging to gauge the underlying profitability of their business operations. This is particularly true of the small and fragmented banks that predominate in many southern European countries. But, as last year’s failed merger between Commerzbank and Deutsche Bank showed, profit concerns are not exclusively limited to lenders in those countries.
The convenient boost to profits that the TLTRO has provided has allowed some banks to escape scrutiny, because there is less urgency to address underlying structural or governance issues. And because weaker banks are not faced with the real or imminent possibility of a crisis, they have the luxury of procrastination.
The ECB rightly thinks bank sector consolidation is going to improve financial stability and profitability, ultimately leading to healthier lending. But larger and more stable banks are not likely to view acquisition targets as being palatable just because they are functioning and have customers.
The ECB’s decision last July to recognise negative good will, or bad will, has gone some way towards addressing valuations for problematic banks. But the ECB could do much more to help separate the good, the bad and the ugly. Once economic recovery is fully re-established, a recalibration of the TLTRO would be one of the best ways to do that.