The European Central Bank published a working paper analysing why banks often borrow reluctantly from central bank backstop facilities and do not convert borrowed liquidity into loans, even absent stigma. The paper develops a model in which banks fail to internalise the collective gains from stronger activity, and concludes that balance sheet policies can repair the weak link between liquidity provision and credit. In the model, a lender-of-last-resort system that lends freely on non-concessionary terms improves outcomes compared with a laissez-faire regime reliant on fire-sale asset liquidation, but banks still under-intermediate relative to a social optimum. More persistent and cheaper liquidity provision via credit easing and quantitative easing can better align bank borrowing and lending with the policy objective; the authors also relate these regimes to supplying liquidity at the bottom of the interest-rate corridor. Empirically, using euro area bank-level and loan-by-loan data, the paper finds no significant relationship between loans and reserves borrowed from conventional refinancing operations, while lending is robustly linked to structural sources of liquidity such as Targeted Long-Term Refinancing Operations and non-borrowed reserves from quantitative easing, with associated firm-level increases in employment, sales and investment.
European Central Bank 2025-01-07
European Central Bank working paper links bank lending to credit easing and quantitative easing rather than standard refinancing facilities
The European Central Bank's working paper examines banks' reluctance to borrow from central bank backstop facilities and their failure to convert liquidity into loans. The study suggests balance sheet policies, including credit and quantitative easing, can enhance the link between liquidity provision and credit. Empirical analysis shows lending is more strongly associated with structural liquidity sources like Targeted Long-Term Refinancing Operations than with conventional refinancing operations.