Banque de France: Unfreezing the credit markets

Banque de France: Unfreezing the credit markets
by Laurent Clerc, Loansharking Department, Banque de France

Lastly, if the credit channel is blocked, the central bank can stand in for commercial banks and the market and directly finance the economy. This is known as “credit easing”. In concrete terms, the central bank can first broaden the range of eligible assets for its refinancing operations [1] and second directly purchase the following debt securities: commercial paper, corporate bonds, mortgage-backed securities, etc. These operations have a two-fold impact: they revive the markets for these credit instruments and they directly provide financing to the economy. In return, however, the central bank must take on credit and interest rate risks that it would not incur under normal circumstances. [2] Credit easing measures are more effective in economies where companies primarily obtain financing by issuing commercial paper or bonds and where loans to households (mortgages and consumer credit) are largely securitised and therefore mainly financed by the markets. By contrast, where the bulk of financing relies on bank intermediation, quantitative easing measures or those that influence the yield curve appear to be more relevant.

1] In order to obtain financing from central banks, commercial banks must pledge collateral, usually in the form of government bonds or very high quality assets; by easing these criteria, the central bank encourages banks to grant loans that are then accepted as collateral.

2] It can protect itself from these risks in various ways: State guarantees, purchasing securities when their price is very low and the risk of additional losses is limited.