The interbank market one year after Mario Draghi presidency at the ECB
Restoring the smooth functioning of the interbank markets was a key objective for Mario Draghi when he became president of the ECB. One year and two LTROs later, the ECB reached its target.
By Urszula Szczerbowicz
Post
Mario Draghi became the ECB president on November 1, 2011 when the sovereign debt crisis in the euro area was at the crossroads. The Greek Prime Minister's proposal to submit to referendum the bailout deal with the EU questioned the future of Greece in the euro area, and this uncertainty spread to the other peripheral countries. Banks in the euro area, exposed to sovereign debt and undercapitalized, refused to lend to each other. As a result, the difference between the interbank rate without collateral and the risk-free rate - Euribor-OIS spread - reached a level comparable to the level of the subprime crisis: about 80 basis points (against 5 bps before 2007). This spread reflected the significant liquidity and risk premia in the interbank market.
Mario Draghi had already stressed the importance of the interbank market when he was Governor of the Bank of Italy: "Restoring the smooth functioning of the interbank markets globally and within the euro area is a precondition to ensure the stability of credit flows to households and firms", he said in October 2008 [1]. It is not surprising that since the beginning of his presidency, the ECB has implemented various measures to fight against malfunctioning of the interbank market. The first exceptional measure was to provide banks with unlimited amounts of three-year loans (3-year LTRO) at a fixed rate, which no other central bank had done before. Two three-year operations were carried out: the first on 21 December 2011 and the second on 29 February 2012, for a total of around €1 trillion. The banks were reassured about their longer-term refinancing and began to lend to other banks for longer periods. We observe in Figure 1 that 3-year LTROs were followed by a significant and sustainable reduction of the Euribor-OIS spread.
Although the two 3-year LTROs were of vital importance to cover banks' liabilities maturing in 2011 and 2012, a significant portion of the funds was borrowed for precautionary reasons and deposited later at the ECB overnight deposit facility (Figure 2). As a result, the ECB took another exceptional measure on 5 July 2012: it set the interest rate on overnight deposits at the ECB at 0%. The ECB encouraged then the euro-area banks to convert the cash they received during the two long-term refinancing operations into credit to businesses and households rather than hold it in the form of deposits at the central bank. Subsequently, the volumes of overnight deposits at the ECB decreased significantly and the fall of the interbank spread seems to confirm that this measure was effective in reviving the euro-area interbank market (Figure 1 and 2). At present, the interbank spread in the euro area (Euribor-OIS) is lower than the interbank spread for lending in dollars (Libor-OIS) for the first time since the beginning of the sovereign debt crisis. Moreover, the euro-area interbank spread has returned to its normal level before the subprime crisis (about 5 basis points).
Although the decrease in interbank spread reflects the greater confidence of European banks, the key but unresolved issue is whether this return to normal functioning of the euro-area interbank market will result in increased lending to economy.
Mario Draghi had already stressed the importance of the interbank market when he was Governor of the Bank of Italy: "Restoring the smooth functioning of the interbank markets globally and within the euro area is a precondition to ensure the stability of credit flows to households and firms", he said in October 2008 [1]. It is not surprising that since the beginning of his presidency, the ECB has implemented various measures to fight against malfunctioning of the interbank market. The first exceptional measure was to provide banks with unlimited amounts of three-year loans (3-year LTRO) at a fixed rate, which no other central bank had done before. Two three-year operations were carried out: the first on 21 December 2011 and the second on 29 February 2012, for a total of around €1 trillion. The banks were reassured about their longer-term refinancing and began to lend to other banks for longer periods. We observe in Figure 1 that 3-year LTROs were followed by a significant and sustainable reduction of the Euribor-OIS spread.
Although the two 3-year LTROs were of vital importance to cover banks' liabilities maturing in 2011 and 2012, a significant portion of the funds was borrowed for precautionary reasons and deposited later at the ECB overnight deposit facility (Figure 2). As a result, the ECB took another exceptional measure on 5 July 2012: it set the interest rate on overnight deposits at the ECB at 0%. The ECB encouraged then the euro-area banks to convert the cash they received during the two long-term refinancing operations into credit to businesses and households rather than hold it in the form of deposits at the central bank. Subsequently, the volumes of overnight deposits at the ECB decreased significantly and the fall of the interbank spread seems to confirm that this measure was effective in reviving the euro-area interbank market (Figure 1 and 2). At present, the interbank spread in the euro area (Euribor-OIS) is lower than the interbank spread for lending in dollars (Libor-OIS) for the first time since the beginning of the sovereign debt crisis. Moreover, the euro-area interbank spread has returned to its normal level before the subprime crisis (about 5 basis points).
Although the decrease in interbank spread reflects the greater confidence of European banks, the key but unresolved issue is whether this return to normal functioning of the euro-area interbank market will result in increased lending to economy.
Figure 1: Evolution of interbank spreads (loans in euro vs. loans in dollars), in %
Figure 2: Overnight deposits at the ECB
Figure 2: Overnight deposits at the ECB
[1] "Financial stability and growth - the role of the euro", Speech at the "Europe and the Euro" Conference, NBER-Bocconi University, Milan, 17 October 2008.
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