Long-term refinancing operations (LTROs) have been around for years in the euro zone – but the European Central Bank launched them in a new form to tackle the debt crisis.
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Essentially, they involve the central bank lending money at a very low interest rate to euro zone banks, which has led to the term “free money.”
The injection of cheap money means that banks can use it to buy higher-yielding assets and make profits, or to lend more money to businesses and consumers – which could help the real economy return to growth as well as potentially yielding returns.
Banks can use assets such as sovereign bonds as collateral for the loans – although they can no longer use Greece's bonds as collateral after the country was downgraded to a default rating by Standard & Poor’s. This has helped to boost some of the more troubled sovereign bonds, in peripheral countries such as Spain and Italy, as their yields have fallen because they are being used as collateral for the operations.
This can help out the entire country. Spanish and Italian banks, the biggest buyers in the last operation, used their holdings of their own sovereign bonds as collateral for the LTROs. This helped reduce sovereign bond yields, which were threatening to stay at unsustainable levels that would make debt repayments impossible.
In previous auctions, the money usually had to be paid back within three months, six months or 1 year. The ECB’s launch of three-year LTROs in December meant that this time scale was extended, which helped cause a much greater takeup than usual.
