Balance sheet recessions are typically not very responsive to traditional demand management measures. This is because the monetary policy transmission channel is impaired by the weak balance sheets of banks and the corporate sector. As long as asset quality is poor and capital is inadequate, banks will tend to restrict overall credit supply. Liquidity may not be a binding constraint in such a situation.
As has been argued by some analysts in the context of an unexpectedly low take up in the recent first auction of liquidity under the ECB’s TLTRO programme, the profitability of borrowing very cheaply for the central bank to lend to the private sector (especially SMEs) is not guaranteed if nonperforming loans are high and banks would need to discount high expected default rates and if lending to SMEs implies high risk weights and, consequently, capital charge.