ECB discusses blocking banks from billions of euros windfall if interest rates rise

The European Central Bank is looking for ways to prevent banks from making billions of euros in extra profit from the ultra-cheap credit system it launched during the pandemic once it starts raising interest rates later this month.

The €2.2 trillion in subsidized loans provided by the ECB to banks helped avert a credit crunch when the Covid-19 crisis hit. But with the central bank planning to raise interest rates, analysts say it will bring a plethora of additional income worth up to €24 billion for euro-zone lenders.

According to three people familiar with the plans, the ECB’s Governing Council will discuss how to reduce the extra margin hundreds of banks can earn from their subsidized loans by simply putting them back in the custody of the central bank.

People said it would be politically unacceptable for the ECB to offer banks taxpayer-supported profits while raising borrowing costs for households and businesses and most commercial lenders pay bonuses to staff and pay dividends to investors.

The ECB has said it plans to raise its deposit rate to minus 0.25 percent at its July 21 meeting, while signaling that a larger hike in September is likely to push interest rates above zero for the first time in a decade, followed by further increases if inflation remains high.

One option could be for the ECB to change the terms of the loans to reduce the chance for banks to automatically recoup the money, just as it made them more attractive after the pandemic started in 2020.

Defending its cheap loans to banks, the ECB said: “Without them, the pandemic would have hit the real economy much harder.” It declined to comment on how it might prevent lenders from making windfall gains.

Morgan Stanley estimated that banks could earn between €4 billion and €24 billion in additional profits by placing the ECB’s cheap loans from last month through the settlement’s end in December 2024 on deposit with the central bank, depending in part on how fast interest rates will rise in the near future. months.

A person briefed on the matter said the ECB estimated that the total profit available to banks was almost half of the maximum estimate by Morgan Stanley. More than 740 banks applied for the loans at their peak in June 2020, when €1.3 trillion was disbursed, but the total number of participants in the scheme is not publicly available.

The ECB started offering the loans in September 2019, the so-called targeted longer-term refinancing operations (TLTRO). Initially, they were available at the ECB’s deposit rate of minus 0.5 percent. But after the pandemic hit, the ECB cut interest rates to minus 1 percent, effectively causing banks to pay even more to lend, provided they don’t shrink their loan portfolios.

The ECB cut the TLTRO rate back to its deposit rate last month. But crucially, the interest on the loans is calculated as an average over their three-year term. Banks can repay the money early every three months. Last month, prepayments amounted to €74 billion, much less than expected, reflecting the increased attractiveness of the scheme as interest rates rise.

“Some banks have double checked their profit calculations with the ECB and then have abandoned the idea of ​​paying them back early,” said an official.

Fabio Iannò, senior credit officer at Moody’s, said: “We expect European banks to hold on to their TLTROs as long as possible because it’s just free money.” He predicted that most of the ECB’s liquidity would not fund loans, but would be deposited with the central bank.

Morgan Stanley calculated that if the ECB raised its deposit rate to 0.75 percent by the end of this year, a bank that took out a TLTRO loan in June 2020 could earn a 0.6 percent profit margin on the money until it’s repaid in June. June 2023.

“This trade has been quite profitable for us,” said the chief financial officer of a European bank. “It was hard for banks to shout out loud about it – you don’t want to say that as a bank you benefited from the pandemic.”

Although the ECB does not provide bank data, French lenders were the biggest users of cheap liquidity with an exposure of almost €500 billion in April, followed by their competitors in Italy and Germany.

At Germany’s largest lender, Deutsche Bank, the €44.7 billion in TLTRO loans was equivalent to about 9 percent of the total €481 billion in loans.

Last year, Deutsche’s interest income of €494 million was supported by the ECB’s subsidized liquidity, or 15 percent of pre-tax profits. Deutsche, which counts TLTROs as a “government grant” in its accounts, declined to say how much was deposited at the ECB.

A person familiar with the bank’s decision-making said that “a carry trade versus cash was not the aim of Deutsche Bank’s TLTRO participation”.

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