Insider – ECB about to change rules for super-cheap long-term loans
Washington According to insiders, the monetary authorities of the ECB are about to reach an agreement to change the rules for super-cheap long-term loans to banks worth trillions. With such a step, the euro watchdogs would reduce the risk-free extra profits of the financial institutions in the currency area by tens of billions of euros, people familiar with the discussions told Reuters.
“We are very close and a decision will come soon,” one of the insiders said on the sidelines of the annual meeting of the International Monetary Fund (IMF) and the World Bank. “The final design will hurt the banks and that is our intention,” the person added.
Council member Gediminas Simkus agrees that the ECB should discuss changing the terms of its long-term lending to banks at this month’s meeting.
“The economic environment and the monetary policy situation clearly show that there is a need to discuss the TLTRO requirements,” Lithuania’s central bank governor said in an interview with Bloomberg Television on Thursday in Washington.
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In recent years, the European Central Bank (ECB) has launched a series of targeted credit injections – known in the art as “TLTRO” – to ensure that the institutions have sufficient liquidity during the Corona crisis. The flow of credit to the economy should thus be maintained. The banks in the euro area currently hold funds of around 2.1 trillion euros from such loans.
Due to the unexpectedly strong interest rate hikes by the ECB this year, however, the penalty interest rates for banks have now been abolished and the deposit rate is currently set at 0.75 percent.
The institutes now have billions in risk-free extra profits from the conditions of these loans. All they have to do is park the TLTRO funds at the central bank until the program expires. Such extra profits for the banks had not been considered at the time.
The insiders noted that a decision could be forthcoming at the October 27 rate meeting. Because waiting brings no benefits, it was said. The impact of the changes would amount to around 30 to 40 billion euros a year, one of the insiders said.
According to another person familiar with the plans, the effect could be even larger if interest rates continue to rise, as markets are currently anticipating. It is currently expected that the deposit rate will climb to almost 2.0 percent by the end of the year and be raised even further in 2023. This would significantly increase the additional profits of the banks. An ECB spokesman declined to comment.
Three options are up for debate
Of the three remaining proposals, according to insiders, the simplest option would be to change the original terms of the TLTRO loans so that money parked at the ECB would no longer earn interest at the deposit rate. This would affect all banks equally. However, this option could face legal hurdles, as banks may then file lawsuits, it said.
Another option would be to treat funds from TLTRO loans similar to the fractional reserves held by commercial banks at the central bank. These reserves currently earn interest at 0.5 percent, which is below the ECB deposit rate.
A third option would be some sort of tiering, allowing banks to get cheaper rates up to a certain threshold. From this threshold, a lower rate would apply.
ECB officials argue, among other things, that it is politically unacceptable for banks to be able to rake in large extra profits at a time when the economy is slowing and many households are facing economic hardship.
They also argue that these benefits for banks are inconsistent with the central bank’s current stance of tightening monetary policy. In addition, the very favorable interest on the TLTRO funds means that the profits of the national central banks in the euro area are reduced. In extreme cases, their capital buffers could be depleted to such an extent that governments might then have to initiate recapitalization steps.
More: Dispute over cheap ECB loans to banks