How do banks maintain their liquidity?
How the ECB helps companies and households
Blog entry by Christine Lagarde, President of the ECB
All over the world, governments are mobilizing to fight the coronavirus. Covid-19 is a new type of shock that conventional methods cannot cope with. We need targeted action for those hardest hit by the crisis.
And at the moment these are the companies and families that are suffering from massive income losses and are increasingly worried about the future. The monetary policy measures of the ECB are intended to reach precisely these target groups. As part of our mandate, we have designed our measures in such a way that liquidity reaches those people and economic sectors who need it most.
If we want to understand how these measures work, we need to talk about what makes this crisis special. It has other causes than a financial crisis or an ordinary recession. The sharp economic downturn is a consequence of the inevitable decision to encourage people to stay home. The task now is to prevent healthy companies that have got into this temporary crisis through no fault of their own from collapsing and employees losing their jobs.
The dangers to employment are greater than they have been since the 1930s. For example, in the United States in 2009, there were up to 665,000 new claims for unemployment benefit in one week. In the past two weeks, that number has risen to 3.3 million and then to 6.6 million. Unemployment rates in Europe tend to be slower and less volatile, but there are already worrying signs: The purchasing managers' index recorded a record decline in employment in March.
To avoid long-term damage, we need to maintain as much as possible the state in which the economy was before the pandemic. Various instruments are available for this. On the one hand, government programs to support short-time work. On the other hand, a mobilization of the banking system in order to provide companies with working capital so that they can keep paying their employees and their bills. The economy in the euro area is bank-based. So encouraging lending helps ensure that liquidity quickly reaches every area of the economy.
In addition to this, states and central banks are taking measures that enable banks to do this in the first place. Countries are providing credit guarantees that reduce banks' credit risk: amounts of around 16% of GDP have already been committed for such programs in the euro area. In addition, the ECB is making sufficient liquidity available to eliminate liquidity risks for the banks, while at the same time ensuring that financing conditions remain favorable for the economy as a whole.
In order to achieve these goals, we have taken two types of measures.
On the one hand, we have taken targeted measures on a large scale to ensure that liquidity reaches those who need it most. Through our new targeted credit facility, we are making liquidity available to banks at a negative interest rate of up to around € 3 trillion. The lower limit for the negative interest rate is -0.75%. This is the lowest interest rate we've ever offered. We know from the past that such measures can have an enormous effect. We estimate that the last two rounds of such targeted deals led banks to lend € 125 billion more than they would without these facilities.
In order for the banks to take full advantage of this new facility, we have also introduced a targeted package of measures to relax the criteria for collateral. A particular focus is on smaller companies, the self-employed and private individuals. The national central banks of the Eurosystem can accept loans to companies and the self-employed as collateral for our lending operations, which are covered by a Covid-19 guarantee system. Smaller loans are also permitted as collateral.
These measures make it more attractive for banks to lend to micro-businesses and sole proprietorships, who generally have less access to credit. You can borrow funds at negative interest rates from us for refinancing for up to three years. There are around 22 million self-employed in the euro area. This corresponds to 14% of total employment. The measures will therefore make it easier for a larger proportion of the working population to access credit.
On the other hand, we buy a large volume of public and private sector bonds so that all branches of the economy can benefit from favorable financing conditions. Thanks to our Pandemic Emergency Purchase Program (PEPP) and our other asset purchase programs, we can purchase more than € 1 trillion in bonds by the end of the year. And as part of this program, we can flexibly focus our purchases in terms of asset classes and countries. We have also expanded our purchasing program to include commercial paper, an important source of liquidity for companies. This gives companies additional support with daily cash flow management, and unnecessary downsizing is avoided.
Taken together, these measures show that we will not allow a procyclical tightening of financing conditions during one of the greatest macroeconomic catastrophes of modern times. However, our actions will be more effective if all policies interlock and reinforce each other. In view of this crisis, sufficiently strong fiscal measures must be taken in all parts of the euro area. States must support one another so that together they can take the best possible countermeasures against a general shock for which no one is responsible.
The best way to protect production capacity and employment is to ensure full coordination of fiscal and monetary policies and a level playing field in the fight against the virus. In this way, we can find our way back to sustainable growth and inflation rates as soon as the coronavirus outbreak is over. If all countries do not fully recover, others will suffer. So solidarity is basically self-interest. The ECB will continue to do its part by pursuing the price stability mandate and serving the people of Europe.
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