Whatever it takes. What's the impact of a major nonconventional monetary policy intervention?

Summary

Focus

This paper seeks to analyse how lending conditions responded to ECB President Mario Draghi's "whatever it takes" speech on 23 July 2012, as an example of a major, unconventional central bank intervention. It does so by comparing credit granted and its terms by individual banks to the same borrower in a country not directly targeted by the intervention.

Contribution

Draghi's "whatever it takes" speech was a watershed for the euro area. It addressed a severe deterioration in financial and economic conditions in 2011 and early 2012. To ameliorate these conditions, the ECB President implicitly promised to provide unlimited support to financial institutions, markets and countries in the euro area. With its scale and unexpected character, the declaration had large beneficial effects on the stock prices and credit spreads of banks and sovereigns. By making banks safer, it also made them less prone to take risks.

We study how this large, unconventional central bank intervention in Europe influenced the credit conditions of banks in Mexico. This has several advantages. First, Mexico's financial system was relatively unaffected by the euro crisis, allowing us to disentangle the effects of the intervention from the factors that led to up to it. Second, foreign banks, whether European or otherwise, have an important presence in Mexico, and these banks are differentially exposed to shocks and official policy actions. Third, Mexican authorities collect detailed information on the lending relationships between banks and borrowers. Together, this allows us to cleanly identify and measure the effects of the intervention.

Findings

We show that the intervention reversed prior risk-taking - in terms of volume, price and risk ratings - by subsidiaries of euro area banks relative to other local and foreign banks. While, before the intervention, euro area banks were pricing their loans more aggressively than other banks were, afterwards lending standards fell back into line with those of other banks. Our results thus document a new effect of interventions: when a bank's franchise value is under pressure, say due to a worsening home market, it may aim to preserve its overall profitability by taking on more risk globally. We show that central bank interventions can reverse this behaviour ex post. Preferably, this would be done ex ante. But this risk-taking can be difficult to detect in real time. Our analysis thus suggests the need to pre-emptively adapt the cross-border regulation, supervision and resolution of global banks to make these measures well integrated, so as to ensure not only that risks do not go undetected, but also that incentives remain well aligned.

Abstract

We assess how a major, unconventional central bank intervention, Draghi's "whatever it takes" speech, affected lending conditions. Similar to other large interventions, it responded to adverse financial and macroeconomic developments that also influenced the supply and demand for credit. We avoid such endogeneity concerns by comparing credit granted and its conditions by individual banks to the same borrower in a third country. We show that the intervention reversed prior risk-taking - in volume, price, and risk ratings - by subsidiaries of euro area banks relative to other local and foreign banks. Our results document a new effect of interventions and are robust along many dimensions.

JEL classification: E51, F34, G21

Keywords: unconventional monetary policy, credit conditions, spillovers