The special operations, carried out on 21 December and on 29 February, enjoyed broad demand from institutions in the euro area. Not only was total participation very high, at over EUR 1,000 billion, the number of participating banks was also much higher than usual, in particular in the second operation, with 800 banks participating.
The operations aim to avoid a decline of bank lending in the euro area. Their effectiveness depends not so much on their size as on the attractive conditions applied by the Eurosystem: a very long maturity of three years combined with low pricing. These favourable conditions, plus the dire straits in which many European banks currently find themselves, explain why the demand for liquidity in these operations was much higher than the amount the European banks really need:
- Usually, European banks provide for adequate distribution of the available liquidity through short-term lending and borrowing on the interbank money market, where the liquidity surplus of one bank makes up for the shortage of another. Owing to the crisis, however, the interbank money market has been disrupted for several years. Banks are reluctant to lend liquidities, especially to peer institutions with a lower perceived creditworthiness
- At the same time, many banks have difficulty in obtaining longer-term funding. Over the next few years, large amounts of longer-term debt will mature, and banks will have to either roll over these debts or redeem the principal. A bank that is unsure about whether it will be able to renew its debts will be reluctant to extend loans to clients, because it may need the money to repay its own creditors. Thanks to the longer-term loans from the Eurosystem, banks are able to support their lending business and at the same time create a buffer in case they need to redeem loans they are unable to roll over. Thus the European banking industry is given the breath of air it needs to carry out necessary balance sheet reforms in an orderly fashion without putting an unnecessary drain on lending. Eventually, the reforms should enable banks to redeem their loans from the Eurosystem.
- The favourable price-setting provides an additional incentive to banks to support their lending activities. By on-lending the liquidities from the LTROs to their clients at higher rates, banks may make an additional profit, which also helps to strengthen their financial buffers.