François Villeroy de Galhau, governor of the Banque de France, proposed a new longer-term refinancing operation in a speech on Friday to help address shortfalls and “prevent unwarranted fragmentation” among eurozone banks.
A new term funding facility could help smaller firms approach the looming targeted longer-term refinancing operations (TLTRO) cliff edge. But if the ECB is to introduce such a scheme to smooth the transition back to market funding, it must make sure it does so in a way that does not simply kick the funding can down the road. It is important that banks are able to fund themselves in the rough and tumble of public markets rather than relying on cheap official sector cash.
Banks have just under €2.2tr of TLTRO funding outstanding, the bulk of which is set to mature in June 2023.
Even if eurozone banks were to return to their pre-pandemic funding levels, having raised €327bn across senior secured and unsecured formats in 2019, they would barely make a dent in refinancing what is set to mature.
With markets as volatile as they are, it will be even harder and more expensive for small, less well rated banks to raise the capital they need if every lender is kicked out of the ECB's nest at once.
As a result, something is needed to make sure firms sharply do not tumble into a funding abyss over the next 18 months.
Although larger lenders have secured themselves a welcome return to market funding since the coronavirus crisis and the end of several years of bountiful TLTRO funding, many smaller, less frequent names are yet to do the same.
A new LTRO, as suggested by Villeroy, would go far in helping smooth the refinancing needs of smaller banks with less of a capital markets presence faced with the end of the TLTRO.
Top names and national champions have firmly re-established themselves across maturities and asset classes in the euro market. BPCE, for instance, finished its non-preferred and tier two funding in February, before taking a chunk out of its senior needs in April.
However, many smaller FIG issuers are yet to return to the market in 2022, and those second tier banks that have already done so paid up for the privilege.
Even with a green label, De Volksbank had to offer a 25bp concession in late April to land €500m of five year non-call four non-preferred funding, for instance. Meanwhile, earlier that month Crédit Agricole placed a €750m note with the same tenor with only 7bp of premium.
Two tier liquidity
Of course, not every firm would have to rely on a new term funding scheme to ease their exit from the TLTRO. Furthermore, the ECB should want to see the eurozone's more established names stand on their own two feet in the capital markets.
However, restricting or targeting such a scheme to the smaller banks that would derive the greatest benefit could open a two tier funding model in Europe: the more established names left to fend for themselves in the public markets while the tiddlers remain clamped to the mighty central bank's teat.
Perhaps this sort of scheme might fall foul of the EU’s own state aid rules, with the potential for cheap central bank funding to offer smaller firms a competitive edge.
Even then, how does the ECB decide between the LTRO haves and have nots?
Instead, the central bank could perhaps look at offering a funding level that although cheaper than what the riskiest banks might have to pay, it is not too cheap the larger more regular funders choose to lean on it.
Villeroy’s proposal was for a new liquidity backstop linked to the main refinancing operations (MRO) rate, which is 0% — 50bp above the ECB’s deposit rate.
But even then, this level is far below what firms are paying for their senior funding. Last week, for example, Austria’s Hypo Noe printed a Aa1 rated covered bond at yield of 1.652%.
Perhaps, to discourage dependence on the new funding operations, the central bank could look at means testing the lending, restricting the funding to those banks that need it based on their cost of funding or size of balance sheet, for instance.
There is already a precedent for means testing TLTRO lending. During the coronavirus pandemic, the ECB offered banks that met certain consumer and business lending conditions a lower rate of minus 100bp on their TLTRO drawdowns.
Of course, the central bank is not in favour of offering such low beneficial rates again on its term funding, with Villeroy stating in October that the rate was “no longer justified.”
However, even then a new round of LTRO at a higher rate, linked to the MRO as suggested, would still help smaller firms roll off and refinance their TLTRO holdings.
And with the MRO rate 100bp higher than the most attractive drawdown rate offered during the TLTRO programme, there is already less of an incentive for banks to kick the refinancing can down the road.
Furthermore, a new round of refinancing operations would ease the funding pressure on banks’ senior debt programmes, with many favouring covered bonds to refinance their TLTRO holdings.
However, plenty of small firms still have minimum requirement for own funds and eligible liabilities (MREL) shortfalls that they need to close, and although covered bonds are a cheap way of refinancing TLTRO holdings, they will not help firms meet their regulatory needs.
Instead, a new LTRO would ease some of the pressure on these banks to issue covered bonds for refinancing, freeing them up instead to focus on closing gap on their regulatory targets.