The LTRO is the acronym for Long term refinancing operations which, translated into Spanish, means Long Term Refinancing Operations. As its acronym indicates, the LTRO is a financing method, characterized by the fact that central banks lend money to other financial entities at very low interest rates.
We speak of long-term refinancing because, basically, the central bank is financing (or refinancing, if it is for the second or subsequent time) the corresponding financial institution and this financing will have to be returned to the central bank in the long term ( that is, more than 1 year). LTRO methods were widely used by the European Central Bank during the economic-financial crisis that began in 2008.
LTRO Motivation Why was the LTRO program created?
The financing offered by the LTRO program is one of the solutions that central banks have in the face of an economic recession. An economic crisis can cause the collapse of the financial system of a State, if the banks of that country are very overlapping. If this happens, banks will have a lot of difficulties to finance themselves in the market, since they will demand very high interest rates (due to the uncertainty it produces). This can lead to banks not having the capacity to flow credit to private agents (that is, they cannot grant loans) and some may even fail.
To avoid this situation, central banks, through an LTRO program, lend money to banks at a low interest rate; less than what they could get on the market. In this way, financial institutions can now grant loans to other private agents and avoid the collapse of the financial system.
The LTRO is not the only method central banks have to combat recessions. Another very common program is the purchase of public debt. The difference with the LTRO is that in the purchase of public debt the central bank acquires the country’s debt directly, while in the LTRO it lends the money to financial entities so that they can redistribute it among society.
Criticisms of the LTRO
LTRO programs have not been without criticism. As we have just mentioned, the main objective of this program is for financial institutions to grant loans to private agents thanks to the low-interest financing granted by the central bank. However, what has been criticized is that many financial institutions obtain this financing at a low interest rate, but then do not grant loans to private agents. In this way, they take advantage of central bank financing to obtain cheap money, without distributing it later.
One of the solutions proposed is that access to this financing is contingent on the subsequent granting of loans. In other words, forcing a financial institution to return the amount obtained if it is financed through an LTRO program and does not grant loans.