04 November 2019

ECB: Working paper: The impact of central bank liquidity support on banks’ balance sheets

Authors examine the differential developments of the balance sheets of 172 euro area banks at the time of two types of long-term refinancing operations by the Eurosystem: VLTROs and TLTROs, respectively.

They test several hypotheses on banks’ strategic responses to central bank liquidity support that emerge from the literature, while addressing potential selection bias by using propensity score matching techniques.

The outcomes of difference-in-differences panel regressions indicate that banks’ balance sheets developed differently at the time of the two types of refinancing operations. After performing a battery of tests, their most robust findings can be summarised in Table B9.

With regard to the solvency position of borrowing banks, they do not find a relationship between refinancing operations and the pace of deleveraging by high borrowing banks. As in previous studies, they find evidence that central bank borrowing operations are accompanied by carry trades.

Banks borrowing more than the sample median held more government bonds. Authors find this for VLTROs, but not for TLTROs. The latter were associated with a decline of government bond holdings by high borrowing banks, which differed significantly from low borrowing banks.  

In sum, while these policies were instrumental in mitigating the effects of financial market stress on the banking system, their findings provide only mixed support to certain (theoretical) predictions in the literature that central bank funding can have material impact on banks’ balance sheets that may not be aligned to the initial goals of the operations.

They find that banks borrowing in unconditional refinancing operations did more carry trades. In contrast, for conditional refinancing operations, i.e. TLTROs, they do not find this.

In fact they show that, if anything, banks decreased their exposure to sovereigns, which implies that the TLTROs successfully shifted the relative return away from purchasing sovereign bonds, by incentivising lending. The policy implication of our results is that it may be more effective to make long-term central bank refinancing conditional on banks’ behaviour.

Full working paper on ECB

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