Indian economy had slowed down even before the advent of coronavirus (COVID-19). Among other things, the market was gripped by a credit crunch. Thankfully, the RBI intervened and announced several cuts in the repo rate and conducted TLTRO, under what is known as the LTRO. Both LTRO and TLTRO are relatively new for us but these financial tools can address liquidity crunch, boost the economy and also impact personal finance, that is the rate of interest you pay and receive.
So, we have written two articles explaining what is LTRO and what problem it solves in this article. The post also discusses the influence that LTRO and TLTRO have on the macro. The sequel, Credit crunch and LTRO Part 2 narrates how LTRO worked for India and also dives into the micro-levels of the economy, that is, how this financial tool impacts the borrower and investors. So, stay tuned!
The article covers:
What is LTRO?
Coined as LTRO, the long term refinancing operations, is a financial tool first introduced by the European Central Bank (ECB) during the European sovereign debt crisis. ECB used LTRO to lend low-interest rate loans to eurozone banks and help them address financial and liquidity issues.
TLTRO—targeted long term refinancing operations—on the other hand, means LTRO targeted at a particular segment of the economy. For instance, TLTRO can be LTRO targeted at specific segments such as commercial banks, non-banking financial corporations, and micro-financial institutions.
How does LTRO work?
LTRO is conducted through an auction where banks bid for liquidity under the operation. The RBI first ascertains the amount of liquidity to be infused into the system. It then determines the rate of interest, which currently is the prevailing repo rate. Next, the participating banks bid against each other to win the available liquidity.
Further, loans offered under the TLTRO scheme can have a tenure ranging from 1 to 3 years. This means, the banks are required to repay the loan to RBI within 3 years from the borrowing date. That said, the banks can only avail loans under TLTRO after pledging collateral in the form of government securities with the RBI. These securities can either have the same tenure as the loan or higher.
How does TLTRO boost the economy?
Everything is interconnected. That is to say, banks lend to businesses. They, in turn, produce goods and services and contribute to economic activities. But what happens when businesses don’t get loans? What will become of the economy? That is when the RBI steps in as it did now.
By offering TLTRO, the RBI injected cheap funds into the lending system and increased liquidity. This encourages banks to offer loans to businesses, who can kick-start their operations. Besides, banks can also use these funds to earn high returns by investing in attractive assets. Ultimately, this helps banks to tidy their balance sheet.