What it means
Central banks normally influence borrowing costs by setting a short-term policy rate and trusting it to pass through to loans and bonds. In a credit crisis that transmission breaks, and cutting the policy rate to near zero does nothing if lenders will not lend at any rate.
Credit easing attacks the blockage directly. The central bank buys corporate bonds, commercial paper or asset-backed securities, or lends to banks on condition they expand lending, which puts a floor under prices in those specific markets and restores confidence for other buyers.
The measurable effect shows up in credit spreads rather than in the risk-free rate. When a central bank announces it will buy corporate paper, the spread that issuers pay above government yields typically compresses within days, and issuance that had stalled resumes.
The mechanism carries real trade-offs. The central bank takes credit risk onto its own balance sheet, chooses which markets to support, and risks encouraging borrowers to take on debt they cannot service once the support ends.
The distinction worth holding onto is one of composition rather than size. Quantitative easing is about how much the central bank's balance sheet grows; credit easing is about what it holds, and the same total can be assembled from very different assets with very different effects.
In practice
Real-world examples.
Example
A central bank launches a commercial paper facility after the market freezes. A utility that had been unable to roll $300,000,000 of 90-day paper issues successfully the following week at 55 basis points over the benchmark, having been quoted 340 basis points a fortnight earlier.
Example
A central bank offers banks four-year funding at a discounted rate on the condition that net lending to small businesses grows. One participating bank draws $2,000,000,000 and cuts its standard small business margin from 4.5% to 3.1% to meet the lending target.
Example
A programme buying asset-backed securities restarts a stalled auto loan securitisation market. A finance company that had stopped writing new car loans resumes lending within two months because it can once again sell the loans it originates.
Formula
Calculation
Credit easing has no defining formula, but its benefit to a borrower is measured through the fall in the credit spread.
Annual Interest Saving = Debt Raised x Reduction in Credit Spread
Before a credit easing programme, an industrial issuer's five-year bonds price at a spread of 3.2% over the government curve. The central bank then announces direct purchases of corporate paper, and within a quarter the same issuer's spread compresses to 1.7%, a fall of 3.2% - 1.7% = 1.5%.
On a $40,000,000 bond issue, that is $40,000,000 x 0.015 = $600,000 less interest per year, and $600,000 x 5 = $3,000,000 across the full life of the bond.
The wider effect is larger still. If the same 1.5% compression applies across $50,000,000,000 of corporate issuance in that market, the aggregate annual saving to borrowers is $50,000,000,000 x 0.015 = $750,000,000, which is the point of the policy: the central bank buys a modest amount and the price effect reaches every comparable issuer.Case study
Seen in the real world.
Meridian Rail Components is a fictional manufacturer used here purely as an illustrative example. It needed to refinance a $40,000,000 bond maturing in nine months, and in the depths of a credit freeze its bankers indicated the deal was simply not placeable at any price.
Two months later the central bank announced it would purchase corporate bonds of exactly Meridian's rating and maturity. Meridian never sold a single bond to the central bank, but the announcement brought other buyers back, and the company issued at a spread of 1.7% rather than the 3.2% previously indicated, saving $600,000 a year.
The illustrative lesson is that credit easing often works through the announcement rather than the purchases. The central bank changed what buyers believed about the market, and that belief did most of the work.
Watch out
Common mistakes.
- Using credit easing and quantitative easing interchangeably. Quantitative easing is defined by the size of the balance sheet expansion, credit easing by the private sector composition of what is bought.
- Assuming it is free money for the central bank. Holding corporate debt exposes the central bank to genuine credit losses that ultimately fall on the taxpayer.
- Expecting it to help every borrower. Programmes target specific instruments and rating bands, so unrated small companies usually benefit only indirectly through bank lending.
Questions
People also ask.
Does credit easing cause inflation?
It can if it is large and sustained, but its immediate purpose is repairing credit supply, which is disinflationary when it is failing.
How is it withdrawn?
Usually by letting purchased assets mature without reinvestment, which is slower and less disruptive than selling into the market.
Can a business plan around it?
Only opportunistically, by having documentation ready to issue or refinance quickly, since the windows opened by such announcements can close within months.
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