European Central Bank: Fine-Tuning Operations

Credit in the European interbank market tightened in August 2007 as banks sustained losses in mortgage-backed securities markets. On August 9, the European Central Bank (ECB) announced a EUR 95 billion fine-tuning operation (FTO). The Eurosystem continued providing FTOs carrying overnight maturities through the next three business days. Two more bouts of interbank funding stress--in March and September 2008--caused the ECB to deploy more FTOs. The ECB provided liquidity through 12 emergency, overnight FTOs, all but one at least EUR 25 billion in size. All operations, except the first and last, used variable-rate, fixed-allotment auctions. The first and last operations used a procedure known as fixed-rate, full-allotment, which saw the ECB provide as much liquidity as banks requested at the central bank's policy rate. In October 2008, the ECB tendered its last emergency FTO in favor of its longer-term refinancing operations, which would comprise most of its broad-based liquidity support for the duration of the crisis. However, FTOs were not a tool designed to fight financial crises. They were a technical measure--in other words, the ECB typically used them to tweak reserves to keep interest rates within its monetary policy target range. Crisis usage of FTOs often preceded introductions and expansions of crisis-fighting tools. This sequencing led some scholars to characterize the FTOs as the central bank's first line of defense during the Global Financial Crisis. Though FTOs seemed to halt the spikes in interbank funding spreads, they were ineffective at relieving stress in those markets, a task they were not designed to address.