When rumours about some European banks’ exposure to the US subprime market in August 2007 strongly affected money market interest rates and trading volumes within just a few hours, the ECB reacted by providing liquidity to the banking sector on a short-term basis – first overnight, then for slightly longer maturities. This served to ensure that solvent banks would obtain the liquidity that was disappearing from other sources. The first overnight provision of liquidity by the ECB of almost € 100 billion was demand-driven and revealed the  3  See Allen, F, Chui, M., and A. Maddaloni, A., 2004. “Financial Systems in Europe, the U.S.A. and Asia.” Oxford Review of Economic Policy 20(4):490–508. BIS central bankers’ speeches  3  high uncertainty within the banking sector on the ability to obtain funding from private sources. In general, during the first year of the crisis, there was a high degree of uncertainty on individual exposures, but not yet a very strong perception of more severe problems in the banking sector as a whole. Central bank liquidity provision thus aimed at stabilising interest rates, and ensured that temporary liquidity problems of banks would not create problems for bank solvency. The Eurosystem was able to deal with these tensions by only slightly altering its operations under the standard operational framework. This was due to the fact that the number of counterparties to monetary policy operations has historically been very large in the euro area, and because the standard framework offers quite some flexibility.
Additionally, in December 2011, the Eurosystem announced further enhanced credit support in the form of two repo operations with maturity of up to three years. There are indications that especially these three-year longer-term refinancing operations (LTRO) have proven effective in preventing an abrupt deleveraging. They significantly helped in restoring confidence in financial markets by providing insurance on the ability for banks to rely on ECB liquidity. This has taken pressure off banks to fire-sell assets or to shrink their loan book. In fact, there is some evidence that banks who bid for liquidity at the three-year operations used this liquidity to address the roll-over risk implied by the issuance of debt securities or other funding instruments that will mature over the next few years. At the same time, there is some first evidence that the provision of long-term liquidity has helped in supporting credit provisions, especially in countries more affected by the sovereign debt crisis, therefore helping to address impairments in the transmission of monetary policy. The ECB has recently announced the details of Outright Monetary Transactions (OMT) in secondary markets for sovereign bonds in the euro area in order to address severe distortions in government bond markets which in particular originate in unfounded fears on the part of investors of the reversibility of the euro. OMT also aims to safeguard the monetary policy transmission mechanism in all countries of the euro area, thereby preserving the singleness of the ECB’s monetary policy.