long-term refinancing operation - LTRO
The European Central Bank's long-term refinancing operation is a process by which the ECB provides financing to eurozone banks. The stated aim of the LTRO is to maintain a cushion of liquidity for banks holding illiquid assets, and thus prevent interbank lending and other loan origination from seizing up as they did in the credit squeeze of 2008.
The ECB also provides liquidity to banks through its main refinancing operations, which have two-week and one-month maturities. Until early 2008, the longest LTRO maturity was three months. Since then the ECB has successively introduced six-month, 12-month and 36-month terms for LTRO finance. Each of these new issues has been heavily subscribed, with eurozone periphery banks in Ireland, Italy, Spain and Greece taking the majority of the first 36-month issue in late 2011. The second 36-month issue in February 2012 was closely watched as an indicator of the health of eurozone banks.
The collateral posted to the ECB is valued by applying a haircut to its market value, where the size of the haircut depends on three factors - the type of asset, time until maturity, and its credit rating. Credit ratings are broken down into three classes corresponding to 'double A' or above, 'single A', and 'triple B', on a 'second-best' basis. Eg. to fall into class 2, a security would have to be rated single A or above by at least two major agencies. Alternative forms of rating are acceptable for bank loans which are not rated by the major agencies.
The ECB has waived the credit rating requirement for Greek, Portugese and Irish sovereign debt, although it briefly suspended Greek government debt from being used as collateral when it was rated as 'selective default' by S&P.
A large portion of the financing provided to eurozone banks through the LTRO was used to buy periphery sovereign debt. This became known as the 'Sarko trade' after Nicolas Sarkozy suggested that the LTRO meant that the Italian and Spanish governments could depend on their countries' banks to buy their bonds. The ECB is not allowed to provide direct support to Eurozone governments.