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4 The way ECB faced banks’ liquidity needs in the recent financial crises

4 The way ECB faced banks’ liquidity needs in the recent financial crises

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An Index of Bank Liquidity Creation



147



between the refi rate and the marginal rate of allotment in the main refinancing operations (MROs) became higher and more volatile. Following

this, the ECB decided to replace the variable rate procedure with a fixed

rate full allotment procedure.

Second, since the beginning of the financial crisis of 2007–08, the

importance of long-term refinancing operations (LTROs) has been

increasing. The duration of these refinancing operations is longer than

that of MROs, normally about three months. Before the crisis, the LTROs

accounted for 20–30 per cent of the total liquidity provided. After the

crisis, the percentage of these operations increased to 70–80 per cent.

The duration of LTROs has been increased to 36 months from 2012.

Third, the range of collateral required by the ECB in refinancing operations was expanded in 2008 and 2012. This expansion has meant de

facto acceptance as collateral of less and less liquid assets.

The three types of changes in the tools used by the ECB to control the

liquidity of the system were accompanied by a significant increase in the

size of the budget of this central bank. This, however, was not matched

by an increase in the money supply incompatible with the objective

assigned to the ECB to keep price stables.

The expansion of liquidity, in fact, allowed the ECBto offset the fall

of the money multiplier that occurred both during the financial crisis

of 2007–08 and in the subsequent one of the Eurozone sovereign debt

crisis. This fall can be attributed mainly to forms of liquidity hoarding on

the part of commercial banks. The high liquidity hoarding has resulted

in an increased usage of the deposit facility.

This behaviour was dictated by several factors. On the one hand, the

poor functioning of the interbank market during the crisis has led banks

to a prudent management of reserves. On the other hand, banks, at the

sovereign debt crisis, were allegedly led to a very cautious assessment of

the use of available resources.

At the aggregate level, the liquidity policy of a central bank is expressed

by its net position vis-à-vis its banking system.19 When one considers

the net position of the ECB with regard to the Eurozone banks, several

turning points emerge (Figure 6.4).20

Figure 6.4 shows that the ECB injected a massive amount of liquidity

into the Eurozone banking system only after the 2007–08 banking crisis

had manifested itself in all its seriousness, that is to say after the collapse

of Lehmann Brothers.

The ECB itself had started to re-absorb the liquidity created from the

end of 2009 onwards, when the repercussions of the crisis on the money

market lessened.



148



Morelli, Pittaluga and Seghezza



500000

Trichet



Draghi



400000

300000

200000

100000



–100000



Figure 6.4



Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Apr-12

Jul-12

Oct-12

Jan-13

Apr-13

Jul-13

Oct-13

Jan-14

Apr-14



0



Net lending by the ECB



Source: Authors’ calculations su dati ECB ‘Minimum reserve and liquidity’.



In May 2010, Europe’s financial markets were rocked by the Greek

crisis.21 On 10 May 2010 the ECB announced the adoption of the

Securities Markets Programme (SMP). This programme required the ECB

to purchase public securities on the secondary market. This program

was seen as giving in to the urgent requests coming from countries like

Greece and Ireland that were being affected by a severe financial crisis.22

In the course of 2011, in the context of the SMP the ECB purchased

a massive amount of Italian and Spanish public securities in order to

support their quotation.

Overall, however, the number of purchase operations within the

framework of the SMP was limited. What is more important, however,

is that the added liquidity created through these operations was sterilized.23 This was in order to leave the general stance of monetary policy

unaltered. For this reason, the SMP operations cannot be considered a

form of quantitative easing.24

Accordingly, the process of re-absorbing the liquidity injected into

the system during the 2007–08 financial crisis continued even after the

outbreak of the sovereign debt crisis. In July 2011, when the crisis began

to involve Italy and Spain, the level of liquidity injected into the ECB

system was brought back to the values of early 2008. In the summer

the process became more intense. At the moment when the euro crisis



An Index of Bank Liquidity Creation



149



reached its peak, in other words between October and December 2011,

the ECB even became a net borrower from the Eurozone banks.

The management of liquidity by the ECB is reflected in the trend of

the policy interest rate, which was kept stable during the course of 2010,

in the months following the emergence of the sovereign debt crisis.

Believing the crisis had by then been resolved, on 13 July 2011 the ECB

decided to raise the interest rate on main refinancing operations from

1.25 to 1.50 per cent. The interest rate remained at this level until early

November25 (Figure 6.5).

In December the interest rate on main refinancing operations was

lowered to 1 per cent. A further reduction was decided in July 2012.

The gradual lowering of the policy interest rate was accompanied by a

massive injection of liquidity into the system through LTRO.26

Unlike what happened with the SMP, with LTROs the ECB provided

the banks with added liquidity. Moreover, the maturity of these operations (three years) was significantly higher than the operations envisaged by the SMP (three months). Finally, their amount was significantly

higher.27

The differences in the management of liquidity by the ECB before

and after November 2011 are even more evident if the net refinancing

of the ECB is broken down into the components assets and liabilities

(Figure 6.6).

6

5

4

3

2

1



Jan-07

Apr-07

Jul-07

Oct-07

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Apr-12

Jul-12

Oct-12

Jan-13

Apr-13

Jul-13

Oct-13

Apr-14

Jan-14



0



ECB

Figure 6.5



FED



ECB interest rate on main refinancing operations



Source: Authors’ calculations su dati Datastream.



150 Morelli, Pittaluga and Seghezza

1200000

1000000

800000

600000

400000

200000



Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Apr-12

Jul-12

Oct-12

Jan-13

Apr-13

Jul-13

Oct-13

Apr-14

Jan-14



0



attivo

Figure 6.6



passivo



Assets and liabilities of the ECB towards the banks



Source: Authors’ calculations su dati ECB ‘Minimum reserve and liquidity’.



This breakdown shows how the ECB re-absorbed liquidity from the

system up until July 2011. While its liability position remained substantially stable, the asset position fell drastically.

As can be seen from Figure 6.6, starting from July 2011, at the point

when the sovereign debt crisis became acute, liquidity hoarding by the

Eurozone banks increased considerably. The sovereign debt crisis risked

becoming a liquidity crisis in some Eurozone banking systems. Indeed,

in the face of a crisis of confidence regarding the solvency of the GIPSI

banks, the core country banks28 were less inclined to dispense credit on

the interbank market.

Figure 6.6 shows how after the LTROs the massive injection of liquidity

into the Eurozone banking systems which these led to, liquidity hoarding

gradually lessened.

The question has to be asked how the management of liquidity by

the ECB reflected on the individual banking systems of the Eurozone.

Between the end of 2011 and the middle of 2012, the injection of

liquidity into the banking systems of the GIPSI countries rose significantly. In the same period the quantity of liquid resources injected into

the core countries diminished (Figure 6.7).

The situation became progressively more positive during the course

of 2012, when the banking systems of the GIPSI countries drastically

reduced their liquidity creation. This process can be seen as due to



An Index of Bank Liquidity Creation



151



8.0%

6.0%

4.0%

2.0%

0.0%

–2.0%

–4.0%

2010.06 2010.12 2011.06 2011.12 2012.06 2012.12 2013.06 2013.12

gipsi

Figure 6.7



core



Net financing by the ECB



Source: Authors’ calculations on data taken from ECB Statistical Data Warehouse ‘MFI balance

sheets’. Legend: The y-axis shows the ratio of the liquidity index to total banks’ assets. If the

value is negative, it means that banks create liquidity; if it is positive, banks destroy liquidity.



both supply and demand factors. Having an effect on the demand side

were the restrictive fiscal policy measures which led to a reduction in

domestic demand and GDP. The supply side was affected by the more

prudent behaviour of banks in granting credit, made necessary by the

increased riskiness of clients, the diminished value of guarantees, the

growth in non-performing loans and the growing stringency of the

Basel constraints.

As Figure 6.8 shows, in the period between 2012 and 2013 the gap

between the effective supply of liquidity by the ECB and the need for

liquidity in the GIPSI countries closed significantly.



6.5



Conclusions



The financial crisis of 2007–08 brought banks’ liquidity risks to the attention of academics and practitioners. In this context the Basel Committee

deemed it necessary to require banks to meet not only certain capital

requirements but also certain liquidity requirements (introduced with

Basel III).

At the same time a literature developed, as yet on a small scale,

regarding the ways to measure liquidity risk. The main contributions

to this literature have sought to come up with indicators which express

liquidity mismatch not in the form of a ratio but in absolute terms.



152 Morelli, Pittaluga and Seghezza

–16.0%

–14.0%

–12.0%

–10.0%

–8.0%

–6.0%

–4.0%

–2.0%

2.0%



2003

2003

2004

2004

2005

2005

2006

2006

2007

2007

2008

2008

2009

2009

2010

2010

2011

2011

2012

2012

2013

2013

2014



0.0%



Liquidity creation

Figure 6.8



ECB



Liquidity creation by the banks and ECB financing (GIPSI countries)



Source: Authors’ calculations on data taken from ECB Statistical Data Warehouse ‘MFI balance

sheets’. Legend: The y-axis shows the ratio of the liquidity index to total banks’ assets. If

the value is negative, it means that banks create liquidity; if it is positive, banks destroy

liquidity.



The advantage of these indicators over the Basel III ratios is that

they permit aggregations and thus also make it possible to evaluate the

liquidity risk not only of individual institutions but also of groups of

banks and banking systems.

In line with this literature, this paper has formulated a new measure

of liquidity risk expressed in absolute terms. By defining the weights to

attribute to individual assets and liabilities, this measure, unlike similar

measures, takes into account not only the maturity of the individual

instruments but also the various economic sectors that hold the instruments. On this last point, in particular, it is assumed that relationships

of credit and debit with households and businesses are more stable than

those with other sectors.

On the basis of these assumptions we have worked out an index of

liquidity creation for the banks of the Eurozone. Using this index the

aim was first to show how the sovereign debt crisis that occurred in

the Eurozone in 2010 and 2011 resulted from the excessive creation of

liquidity by most of the banking systems of the GIPSI countries.

This excessive liquidity creation led to the emergence in these countries of large current account deficits covered by foreign debt. In these



An Index of Bank Liquidity Creation



153



countries the crisis of confidence in the solvency of the GIPSI countries

that emerged in the summer of 2011 led to a liquidity crisis. Initially

this situation was addressed by the ECB with great uncertainty and little

resolve. Up until November 2011 the ECB had swept up liquidity from

the system, even raising the policy interest rate from 1 to 1.5 per cent

between April and July 2011. With the arrival of Draghi as president in

November 2011 the management of liquidity by the ECB changed radically. The massive injection of liquidity into the banking systems of the

Eurozone through LTROs, which happened between the end of 2011

and the beginning of 2012, enabled the banking systems of the GIPSI

countries to overcome the most dramatic stage of the crisis. At the same

time, the banking systems of these countries gradually reduced the creation of liquidity and brought it down to normal levels, which are now

close to those of the core countries.



Notes

1. See Allen and Santomero (1998) and Allen and Gale (2004).

2. As Gorton (2009) observes, the financial crisis of 2007–08 took the form of a

run of financial firms on other financial firms.

3. On this aspect, see Gerlach-Kristen and Kugler (2010).

4. With reference to the United States, see Bai et al. (2014).

5. See Allen (1981).

6. See IMF (2011).

7. See, on this point. Caballero and Krishnamurthy (2001).

8. See Basel Committee on Banking Supervision (2008).

9. The LCR assumes that a bank holds a stock of unencumbered high-quality

assets (HQLA) equal to or in excess of its projected net cash outflows (NCOF)

in a 30 calendar day liquidity stress scenario. The HQLA consists of ‘cash or

assets that can be converted into cash at little or no loss of value in private

markets’. Basel Committee on Banking Supervision (2013, p. 4).

10. The NSFR is defined as the amount of available stable funding relative to

the amount of required stable funding. ‘The amount of such stable funding

required of a specific institution is a function of the liquidity characteristics

and residual maturities of the various assets held by that institution as well as

those of its off-balance sheets (OBS) exposures’ (Basel Committee on Banking

Supervision, 2014, p. 2). ‘Available stable funding’ is defined as the portion of

capital and liabilities expected to be reliable over one year (Basel Committee

on Banking Supervision, 2014, p. 2).

11. See among others Duffie et al. (2007).

12. See Sadka (2010).

13. See. Kashyap et al. (2002) and Gatev and Strahan (2006).

14. See Berger and Bouwman (2009).

15. Namely, Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy,

the Netherlands, Portugal and Spain. The data are taken from the Statistical

Data Warehouse publicly available on the website of the ECB (http://sdw.



154



16.

17.



18.

19.



20.



21.

22.

23.

24.

25.

26.



27.



28.



Morelli, Pittaluga and Seghezza

ecb.europa.eu/browse.do?node=2018811). In particular we have used the

data in the section ‘Monetary and financial statistics’, subsection ‘Monetary

aggregates and counterparts’, paragraph ‘MFI balance sheets’ which reports

data on the breakdown for assets and liabilities of the balance sheets of the

banking sectors of Eurozone countries.

In 2013 this proxy represented a quota of 96 per cent of the Eurozone banking

system.

This excessive creation of liquidity by some Eurozone banking systems was

possible also because of the accommodating monetary policy of the ECB. See

Belke and Gros (2010) and Gros (2011).

For a detailed exposition of this point of view see Krugman (2013) and De

Grauwe (2011).

Net lending by the ECB is defined as the difference of assets and liabilities.

Assets are ECB loans to banks (open market operation and marginal lending

facilities), and liabilities are bank deposits at the ECB (deposit facility and

current accounts).

Data are taken from the ECB Statistical Data Warehouse, under the heading

‘Monetary operations’, subsection ‘Minimum reserve and liquidity’: http://

www.ecb.europa.eu/stats/monetary/res/html/index.en.html

See, among others, De Pooter et al. (2012).

See Whelan (2011).

See the press committee of the ECB on 5 October 2010.

See Fawley and Neely (2013).

For a discussion of the different attitudes taken by Trichet and Draghi, see

Basham and Roland (2014).

Buiter and Rabbari (2012) assert that these operations were introduced by

Draghi not so much to resolve the illiquidity situation of the various banking

systems, but rather to support the quotations of government bonds.

The LTROs in December 2011 and February 2012 amounted to a total of

2 thousand billion euros, while the sum involved in the operations within

the SMP was just slightly over 200 billion euros.

In other words, Germany, France, Austria, Belgium, Finland and the

Netherlands.



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7

The Performance of Listed

European Innovative Firms

Luisa Anderloni and Alessandra Tanda



7.1



Introduction



European venture capital has gained increasing interest in the latest

years by academics, practitioners and policy makers: its relevance in

this area has been growing, and firms located in European countries

have attracted a substantial share of the investments. Traditionally the

literature identifies venture capital (VC) as the form of investment in

start-up and growth companies, which is particularly fitted to overcome the asymmetries of information characterizing new businesses

and firms which are living a series of changes (Gompers, 1995; Brav

and Gompers, 1997). VC is also able to boost the performance of the

target companies thanks to its value-added services, in terms both of

sales growth and employment (Grilli and Murtinu, 2014; Paglia and

Harjoto, 2014) and of stock performance (Bessler and Seim, 2012), or

with reference to corporate governance (Farag et al., 2014), although

the real contribution of VC might depend on the context (Rosenbusch

et al., 2013).

The Initial Public Offering (IPO) is usually assumed to be one of the

preferred exit strategies by venture capitalists (VCs), and a stream of

studies has investigated the effects of the presence of a venture capitalist

on the performance of listed firms, both at IPO and in the long run.

Generally VC-backed firms are expected to have a lower underpricing,

thanks to lower asymmetries of information, and a better performance

in the following years if compared to other listed firms, though empirical evidence provides ambiguous results.

This study aims at evaluating the stock performance of a sample

of innovative European firms that concluded an IPO between 2002

and 2011, operating in the life science and ICT (information and

157



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