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What is a LTRO – Long-term Refinancing Operation

A Look at Europe’s LTRO and What It’s Used For

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The financial industry is famous for its acronyms, from CPA to CDS. But there has been one new acronym that has gained notoriety during the European sovereign debt crisis. LTRO is an acronym that stands for "long-term refinancing operations", which are used by the European Central Bank (ECB) to lend money at very low interest rates to euro zone banks.

How LTRO Work to Support Growth

LTROs provide an injection of low interest rate funding to euro zone banks with sovereign debt as collateral on the loans. The loans are offered monthly and are typically repaid in three months, six months or one year. But the ECB also announced a three-year LTRO in December of 2011, which led to significantly higher demand than past operations.

The LTROs are designed to have a two-fold impact:

  1. Greater Bank Liquidity - Low interest financing enables euro zone banks to increase lending activities and spur economic activity, as well as invest in higher yielding assets in order to generate a profit and improve a problematic balance sheet.
  2. Lower Sovereign Debt Yields - Euro zone countries can use their own sovereign debt as collateral, which increases demand for the bonds and lowers yields. For instance, Spain and Italy used this technique in 2012 to lower their debt yields.

LTRO operations themselves are conducted via an auction mechanism. The ECB determines the amount of liquidity that is to be auctioned and requests expressions of interest from banks. Interest rates are determined in either a fixed rate tender or a variable rate tender, where banks bid against each other to access the available liquidity.

LTROs during the European Debt Crisis

LTROs became popular during the European financial crisis that began in 2008. Before the crisis hit, the ECB's longest tender offered was just three months. These LTROs amounted to just 45 billion euros that represented about 20% of the ECB's overall liquidity provided.

These levels ultimately increased throughout the European debt crisis:

  • March 2008 - The ECB offers its first supplementary LTRO with a six-month maturity is more than four times oversubscribed with bids from 177 banks.
  • June 2009 - The ECB announces its first 12-month LTRO that closes with over 1,000 bidders in sharply higher demand than previous LTROs.
  • December 2011 - The ECB announces its first LTRO with a three year term with a 1% interest rate and usage of the banks' portfolios as collateral.
  • February 2012 - The ECB holds a second 36-month auction, known as LTRO2, that provides 800 euro zone banks with 529.5 billion euros in low interest loans.

Alternatives to LTROs for Liquidity

Shorter-term repo liquidity measures provided by the ECB are called main refinancing operations (MROs). These operations are conducted in the same manner as LTROs, but have a maturity of one week. These operations are similar to those conducted by the U.S. Federal Reserve to offer temporary loans to U.S. banks during hard times.

Euro zone countries can also access liquidity through Emergency Liquidity Assistance (ELA) programs. These "lender-of-last-resort" mechanisms are designed to be very temporary measures designed to help banks during times of crisis. Individual countries have the ability to run these operations with an ECB override option.

Key LTRO Takeaway Points

  • LTRO stands for "long-term refinancing operation" and is used to provide longer-term liquidity than standard MROs to banks during times of crisis.
  • The ECB greatly expanded LTROs during the European sovereign debt crisis from a three-month maturity to a three-year maturity amid sharply higher demand.
  • Other liquidity programs used by the ECB and independent governments include main refinancing operations (MROs) and Emergency Liquidity Assistance (ELAs).

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