On December 10, 2020, the European Central Bank (ECB) extended the third series of its targeted longer-term refinancing operations (TLTRO III) as a further countermeasure to COVID-19 impacts on the capital markets. The aim of further extending the funding channel by three additional bidding dates (TLTRO III 8-10) is to further stimulate an increase in banks’ net lending and thus channel more liquidity to the real economy. The changes entered into force in February 2021 and brought certain relaxation of past criteria as well as a simplification of interest rate calculation which we will discuss in this article.
TLTRO series to stimulate net lending by the banking sector
ECB’s TLTRO operations were established in June 2014 as a first series of so called targeted operations (meaning monetary policy operations with banks targeting lending to the real economy) with an aim to address slow economic growth, weak inflation outlook and subdued monetary and credit dynamics in the euro area. Unlike other ECB’s non-standard funding measures, TLTRO represents an ex-ante funding channel for banks granting loans to the real economy, meaning that the participating entity receives funds upfront from the National Central Bank (NCB) and the final cost for the funding is determined later, depending on whether the entity improved its net lending. By eligible loans in this context, ECB addresses credits issued in euro currency to non-financial institutions and households (except for mortgage loans). The access to TLTRO funds is regulated by legal provisions and fully granted to the applying bank; it includes no bidding mechanism such as other monetary policy instruments. The second and third series (established in 2016 and 2019 respectively) of TLTROs offer additional discounted interest rates, provided that the participants exceed their own past net lending. Providing discounts from the reference rate underpinning the final interest rate payable is the ultimate tool the ECB uses to bring the total costs for the funding to zero or even in slightly negative numbers. The ability to manipulate with interest rate and adjusting the borrowing allowances gives the ECB an effective instrument to address liquidity shortfalls in the Eurosystem’s economy, delivering on its mandate.
TLTRO III measures in anticipation of rising crisis-related financing difficulties in the euro area
Figure 1 below illustrates the type of impact the COVID-19 pandemic posed on corporate entities in Germany in 2020:
Figure 1: Statista and PwC Research
Add. Information: Survey took place in Germany from June 22, 2020 – June 26, 2020 with 7,552 surveyed companies
The numbers show that 11% of firms reported facing difficulties to access debt capital while other 40% reported experiencing liquidity shortfalls. In order to counteract any negative impact of COVID-19 restrictions on the market, ECB revised its liquidity channels by amending both ex-post (e.g. asset purchase programs) and ex-ante (TLTRO) fundings. As a result, further EUR 1.1 trillion was made available through the Pandemic Emergency Purchase Programs (PEPP) (EUR 600 bn June 2020 and additional EUR 500 bn in December 2020) and an extension of TLTRO III by three new operations (8-10) in 2021 was introduced.
Prior to this, however, ECB conducted a research on the effects of TLTRO to examine the effect of additional liquidity on loan granting practices. Empirical evidence suggests that while access to TLTRO positively impacts loan supply to the real economy, at the same time it does not lead to excessive risk taking by the banks when using the TLTRO funds.
Adjustments made by the ECB for the TLTRO III 8-10 operations
ECB has modified certain criteria of the TLTRO III operations since its inception in 2019. It was only last year that ECB released three major addendums to the existing framework which aimed at both increasing and targeting the funding. While all three brought gradually higher interest rate discounts (currently maximum of -1% below the reference rate) and increase of the borrowing allowance, it was the last addendum issued in December 2020 which extended the whole TLTRO III series by three additional operations:
- TLTRO III (8): application deadline on May 10, 2021
- TLTRO III (9): application deadline on August 16, 2021
- TLTRO III (10): application deadline on November 8, 2021
All three new operations will enjoy the latest funding conditions introduced by the ECB on December 10, 2020. While we deem it unlikely that constraints on those three new operations will be introduced in the near-future (i.e. before ECB concludes that the pandemics is overcome from an economic perspective), we rather expect further stimulative changes, following recent trends as outlined in Figure 2:
Figure 2: European Central Bank and PwC Research
The overview above illustrates that adjustments have been made in almost all key areas: interest rate, borrowing allowance and reduction in threshold. When looking more deeply into the underlying regulatory framework, we can see ECB’s clear intention to make the lending conditions more appealing by keeping the interest rate at more favorable levels by pushing the floor to a more negative rate as well as granting higher deductions from the applicable reference rate. This in combination with gradually increasing the borrowing allowance limit at its current value of 55% allows participants to almost double their lending compared to what was available in Q1 2020.
By reading the regulation, one may also notice one qualitative change – the ECB simplified the way it regulates the TLTROs in the new 8-10th operations. The decision tree for calculation of interest rate with combination to applicable benchmark has been significantly simplified which makes the regulation not only more understandable but it also reduces the number of assumptions the applying entity must undertake in order to judge whether hitting its own benchmark is feasible. This improved transparency can be expected to lower the entry barrier for new bidders.
How is the TLTRO III 8-10 assessed?
As outlined earlier in the text, the adjusted TLTRO III (8-10) measures create additional incentive for lending. While determination of the net lending benchmark (NLB) remains unchanged – the sum of net lending from April 2018 until March 2019 and capped to zero, the decision tree used to determine applicable interest rate has been adjusted. The new observation period used to compare actual net lending to the NLB is being referred to as Additional Special Net Lending period and is observed between October 2020 and December 2021. The decision whether the benchmark is reached or not is solely dependent on whether there is any increase in net lending in the Additional Special Net Lending period in comparison to the benchmark for banking institutions having negative net lending in the reference observation period (April 2018 – March 2019). For entities that demonstrated positive net lending in the reference observation period, the requirement for hitting the benchmark remains maintaining positive net lending (i.e. above zero).
Figure 3 shows a decision tree for determining the interest rates to be expected during the lifetime of the operation:
Figure 3: European Central Bank and PwC Research
The interest rate is calculated in the same manner for both scenarios: reaching and not-reaching of the benchmark. Should the benchmark be reached or exceeded, the average interest rate of the deposit facility (DFR) is used and further lowered by 50BP from June 24, 2021 until June 23, 2022 (Special Reference Period). Should the DFR remain at the same level as is now: -0.5%, the total interest rate applicable will be at -1.0%. The remaining term (Second Reference Period) from June 23, 2021 until the TLTRO’s maturity bears interest rate at the level of the reference rate of the deposit facility.
In the second scenario, when the benchmark is not reached, the average interest rate for main refinancing operations (MRO) is applied and further lowered by 50BP in the Special Reference Period. Assuming the rate remains constant the total rate applicable will equal -0.5%. The remaining term of the TLTRO uses the average MRO rate without any further discount.
It is worth pointing out, that in any case of fluctuation of the reference rate, the lowest interest charged is floored at -100BP. Also, for institutions applying for the last TLTRO operation, the time between submission of the application (November 8, 2021) and the end of the Additional Special Net Lending period which determines whether benchmark was reached is relatively small – only 1.5 month. This allows applicants to forecast with a high amount of certainty under which side of the decision tree their financing will fall.
Participation in TLTRO III has recently been extended by three more operations, each falling on one of the next quarters 2021. All three operations offer the most convenient funding options yet available by any previous TLTRO funding. Regardless of lending performance (above or below the benchmark), it is very likely to obtain a zero or negative interest rate for the first part of the funding and slightly below or at zero interest rate costs for the Second Reference Period. For banking institutions, it will be demanding to find refinancing at such a low cost elsewhere on the market.
In addition, the complexity of the TLTRO rules was addressed by making the interest rate calculation more simple and less dependable on other factors. Further incentive in terms of certainty of assumptions can be seen when looking at the calendar. Application deadline for TLTRO III (10) is only 1.5 month before the end of the assessment of the Additional Special Net Lending. We assume that entities applying for the last TLTRO operation will be able to approximate with a high degree of certainty whether they will qualify for preferential discounts provided by hitting their own benchmark by simply having to approximate only 1.5 month ahead of their net lending as the rest of the lending performance will be known to them.
For more information on this topic or on how to apply for TLTRO and what are the other regulatory requirements to maintain compliance with already ongoing funding, please do not hesitate and contact your PwC experts.
 ECB’s Working Paper on TLTRO
 DFR has been at the level of -0.5% since September 18, 2019.
 MRO has been at the level of 0.0% since March 16, 2016.
 Assuming both of the FDR and MRO remain at current levels.