LTRO 2.0

BoE's small-firm stimulus is blueprint for Draghi

The euro zone is no longer collapsing, but credit is. The European Central Bank is reportedly considering giving banks cheap loans to stimulate lending. The Bank of England's so-called Funding for Lending scheme shows that's tricky, but the euro zone shouldn't hold back.

The case for looser euro zone monetary policy is growing. Year-on-year, loans to the private sector in October suffered their sharpest decline on record. The region's capital markets remain fragmented, with companies in stressed countries facing elevated borrowing costs.

One solution could be a so-called "long-term refinancing operation" targeted at small firms, according to Sueddeutsche Zeitung. The precedent is the UK's FLS, where BoE Governor Mark Carney gives banks four-year, cheap funds if they increase lending.

The FLS is an unlikely saviour. Its main achievement in the UK has been to lower banks' borrowing costs and help them delever, not spur a credit boom to small firms. What's more, if ECB President Mario Draghi attempted a euro FLS, he'd face opposition from ECB hawks. To have an impact, funds would need to be long-dated and very cheap, but this might look like a subsidy ahead of next year's stress tests. And giving funds at a fixed rate might look like pre-commitment, which the ECB has historically avoided.

But a euro FLS is an easier sell than unconditional loans, like the ECB's LTROs in 2011, with which banks bought sovereign bonds. Unlike direct purchases of government debt, it wouldn't obviously break ECB rules on monetary financing. And it's less risky than outright purchases of bank loans.

Draghi should also not count on next year's asset review and banking union to improve lending, or enable more aggressive policy. Genuine banking union may take a long time, and credit conditions could tighten further as the US Federal Reserve cuts bond purchases and European banks repay previous LTROs.

Hence the ECB boss should use this week's press conference to unveil his own euro FLS. As in the UK, it may not be a panacea: weak banks may still resist directing money to small firms, given that current capital rules make government debt more attractive. And banks can't be forced to lend, or overcome weak demand. But with politics blocking the ECB from deploying more powerful tools like buying individual loans, a euro FLS may be the best option going.