How have the Bank of England, European Central Bank and Bank of Japan responded to the coronavirus pandemic?

Owing to the US dollar’s status as the global reserve currency, and because trade finance and cross-border bank lending into emerging markets (EM) is primarily in the US currency, the role of the US Federal Reserve (Fed) in response to the COVID-19 pandemic is particularly important to understand.

We have previously written about the Fed and its role in providing dollars during this period of financial stress, but other central banks in large, developed economies have also announced similar sets of measures.

In this article, we summarise and contextualise the responses of the Bank of England (BoE), the European Central Bank (ECB) and the Bank of Japan (BoJ).

Bank of England

The BoE has adopted a “do whatever it takes” strategy when crafting its monetary response to the COVID-19 pandemic, comparable to the fiscal stance of the UK Treasury.

Like the Fed, the BoE is going directly to the corporate sector with a commercial paper financing facility that is unlimited in scale, with the BoE becoming the lender/dealer of last resort.

In addition, the following programmes have been announced by the BoE:

• COVID Corporate Financing Facility (CCFF), which will purchase commercial paper of up to one-year maturity in unlimited amounts and will last for at least 12 months.
• Reduction of the countercyclical capital buffer from 1% to 0%, extending banks’ capacity to lend to businesses by £190 billion (or 8.6% of GDP).
• New Term Funding Scheme funding for banks, offering four-year funding at interest rates close to Bank Rate.
• Contingent Term Repo Facility (CTRF), offering cash in exchange for high-quality collateral for a period of up to three months.
• Bank Rate cut to 0.1% on 19 March, after a prior cut to 0.25% on 11 March 2020.
• Increased purchases of UK government bonds and non-financial investment-grade corporate bonds of £200 billion (9% of GDP), raising current holdings from £445 billion to a total to £645 billion (29% of GDP).

With these measures, the BoE has “attacked” the malicious monetary effects of COVID-19 on multiple fronts.

Primarily, the BoE has increased asset purchases by £200 billion, injecting cash directly into the non-bank private sector because most of its purchases of longer dated gilts will be from non-bank savings institutions.

In tandem with the increased asset purchases, the BoE has promised to purchase unlimited amounts of commercial paper to combat corporate cash flow problems enabling corporates to continue functioning as close to full capacity as possible.

Second, bank capital ratios have been loosened substantially to allow additional bank lending to the private sector of almost £200 billion.

Commercial banks can also tap into the New Term Funding Scheme at very low interest rates, which have now been cut to just 0.1%.

In contrast to the ECB, the BoE has not only aided the banking sector but has also “gone direct” with its purchases of assets outright from the non-bank private sector.

European Central Bank

The ECB has often been slow in responding to crises such as the COVID-19 pandemic.

For example, following the global financial crisis (GFC) although the ECB introduced Longer Term Refinancing Operations (LTROs) fairly early on, it did not enact its quantitative easing programme until 2015, much later than the Fed, the BoE, or the BoJ.

Thankfully, this time the ECB has been much more on the pulse, although many of its programmes focus on supporting the European commercial banking sector, whereas the root of the problem lies in the non-banking sectors of the economy.

The following programmes have been announced by the ECB in response to COVID-19:

• €750 billion (6.3% of GDP) Pandemic Emergency Purchase Programme (PEPP), which will include all the asset categories eligible under the existing asset purchase programme (APP). A waiver of the eligibility requirements for securities issued by the Greek government will be granted for purchases under PEPP.
• All commercial papers of sufficient credit quality will be eligible for purchase under CSPP (Corporate Sector Purchase Programme), as well as expanding the scope of Additional Credit Claims (ACC) to include claims related to the financing of the corporate sector. This does “go directly” to the non-bank private sector, but purchases are relatively small compared to purchases of government bonds from commercial banks. Holdings of corporate bonds by the ECB total just under €200 billion.
• More favourable terms to be applied for the TLTRO III facilities, which are due to start in June 2020. During its period of operation, the interest rate on these TLTRO III operations will be 25 basis points below the average rate applied in the Eurosystem’s main refinancing operations (currently 0.0%). Additional LTROs are to be conducted to encourage bank lending to the private sector.
• General relaxation of banking regulations, allowing banks to operate temporarily below the level of capital defined by the Pillar 2 Guidance (P2G), the capital conservation buffer (CCB) and the liquidity coverage ratio (LCR). Banks will also be allowed to partially use capital instruments that do not qualify as Common Equity Tier 1 (CET1) capital, for example Additional Tier 1 or Tier 2 instruments, to meet the Pillar 2 Requirements (P2R).
• The ECB has recommended that commercial banks do not distribute dividends for the next six months, allowing around an extra €30 billion of capital to be added to the banking sector.

In contrast to the Fed, which “has gone direct” in its unlimited purchases of US Treasury securities to ease monetary conditions, the ECB has focused once again on the banking sector, to a limited (€750 billion) extent.

Since the GFC, banks’ balance sheets have been straitjacketed by the Basel Accords, which have restricted bank lending.

It would therefore have been preferable if the ECB’s measures had emulated the template provided by the Fed by financing the non-bank private sector directly.

Relaxation of banks’ capital/liquidity ratios will help, but a more direct approach to ameliorate corporate cash flow problems is what is really needed.

Bank of Japan

Commercial banks in Japan play an increasingly large role in dollar financing across global value chains.

This means the dollar swap lines that the Fed has re-established will be vital for the Japanese banking sector.

Like the ECB, the BoJ has tended to focus its attention on interest rates and the commercial banking sector, to the detriment of the non-bank private sector whilst ignoring measures of broad money growth.

At a time when the problem related to COVID-19 is a lack of money within the non-bank private sector, this framework could prove to be misguided and ultimately lacking breadth and scope.

Measures already enacted by the BoJ to calm financial markets and bolster resilience are as follows:

• Introduction of the Special Funds-Supplying Operations to Facilitate Corporate Financing, providing loans against corporate debt of around ¥8 trillion (equal to 1.5% of GDP).
• Increases in purchases of commercial paper and corporate bonds, with upper limits increasing to ¥3.2 trillion (0.6% of GDP) and ¥4.2 trillion (0.8% of GDP) respectively.
• Purchases of ETFs and J-REITs of around ¥12 trillion (2.2% of GDP) and ¥180 billion (0.03% of GDP) respectively.

Most of the new measures are far too small in size to provide the liquidity needed for corporates starved for cash as supply chains and their corresponding payments chains are hit hard by COVID-19.

Japanese businesses will have to rely upon the fiscal authorities in Japan, as a timid approach by the BoJ has left them wanting.

Summary

In summary, the BoE has provided ample liquidity to the non-bank private sector, exactly the monetary response needed in response to COVID-19.

The ECB has provided a limited package to incentivise bank lending, but banks, which have been constrained in their growth over the past decade, are likely to be reluctant to expand their balance sheets at this time.

Corporate bonds bought under the CSPP programme will finance the non-bank private sector, but this will be a relatively small enhancement to liquidity.

Finally, the BoJ has offered very little in the way of anything new to help the non-bank private sector at this time, with any increases in existing programmes (such as purchases of commercial paper and corporate bonds) almost trivial in size.