In response to the coronavirus pandemic, the ECB recently announced an asset purchasing programme of € 870 billion, the Pandemic Emergency Purchasing Programme (PEPP), to stabilise the banking sector and encourage banks to extend loans to companies and households throughout the present crisis. This programme mirrors the ECB’s existing Targeted Longer-Term Refinancing Operations (TLTROs) that have been in place since 2014. Critics argue that the impact of TLTRO funding on the real economy has been very limited, at best, and that much of the liquidity made available by the ECB, and other major central banks around the globe, has been diverted by banks to other uses, fuelling ‘bubbles’ in asset prices and funding generous pay-outs to shareholders and staff. Some have therefore asked for central bank funding for banks to be tied to certain conditions to ensure that these funds are actually used to finance the real economy (‘conditionality’).
The concept of conditionality was developed, originally, in connection with the granting of loans by the big multi‑lateral institutions, the World Bank and the IMF, to crisis-hit developing countries. In return for financial assistance, recipient countries had to commit to a package of monetary and fiscal policies to reduce sovereign debt, stabilise the economy, and restore growth. By the 1990s, a standard package of measures, strongly reliant on fiscal consolidation, privatisation, liberalisation, became known, often critically, as the ‘Washington Consensus’.
The first question to address is how the concept of conditionality could be applied in the context of the ECB’s initiatives. This is not obvious because the circumstances are very different: in the case of loans by international financial institutions, such as the World Bank and the IMF:
- The recipients are governments of sovereign states. Governments can enter into obligations towards other countries or international organisations on behalf of their citizens. They have the powers to pass legislation that transposes these conditions into national law. In doing so, they are acting in the public interest and are bound by a legal (constitutional) mandate.
- The management of privately-owned banks, by contrast, is responsible primarily to its shareholders and its first and foremost mandate is to increase shareholder value, mainly by way of increasing the share price and making distributions. National development banks represent a notable exception as they tend to be owned by the public and have a public-interest mandate.
The scope for imposing conditions on privately‑owned banks is fairly limited. The most realistic and effective way of imposing conditions would be to require banks to forego discretionary payments to shareholders and staff (dividends, share buy-backs and bonuses) for as long as they benefit from PEPP funding.
Whether the use of ‘non-standard monetary policies’, such as PEPP and TLTRO, to channel funds to the real economy via the banking sector is an efficient use of public funds, is an altogether different question:
- The use of ‘non-standard monetary policies’ was justified, at the height of the Eurozone crisis, as a way of extending EU funding to support the financial system of fragile member states without overtly infringing the prohibition on monetary financing of fiscal deficits in Article 123 TFEU.
- In view of the coronavirus pandemic, the European Commission has suspended the debt and deficit limits of the Growth and Stability Pact, enabling member states to announce sizable fiscal stimulus programmes that make public funds available directly to affected companies and households.
- Whereas the need for public support to counteract the effects of the pandemic should be self-evident, the uncoordinated parallelism of EU-level monetary assistance to the banking sector and direct fiscal support at the national level is sub-optimal and could even prove counterproductive in some cases.
- In the long run, it would be preferable, in our view, if EU Member states could agree on a coordinated package of fiscal measures that would a) rely less on the efficiency, or otherwise, of the banking sector; b) allow for a more targeted deployment of public funds to support the real economy; and c) reduce the burden on the ECB to step in with monetary policy instruments where political cooperation fails.