Stocksak: ECB eliminates subsidy on bank loans in order to raise cash

© Stocksak. FILE PHOTO – Signage outside the European Central Bank building in Frankfurt, Germany on July 21, 2022. REUTERS/Wolfgang Rattay/File Photo

FRANKFURT (Stocksak), Thursday, the European Central Bank removed a subsidy on multi-year loans to bank to encourage them to repay them earlier. This was done to remove excess cash from banks and avoid political embarrassment.

Because banks were able to make a guaranteed profit at ECB’s expense due to the generous rate they received at the height COVID-19, the ECB is under pressure to alter the terms of its Targeted Langer-term Refinancing Operations.

This source of cheap cash was not only costly for the ECB but also hindered its efforts to lower inflation, currently running at close to 10% within the euro zone.

The ECB stated that banks will now have to pay going interest on their TLTRO credits, instead of the average rate for the loan’s duration.

“From 23 Nov 2022 to the maturity date or early repayment dates of each respective outstanding TLTRO III opera, the interest rate for TLTRO III operations shall be indexed according to the average key ECB interest rates during this period,” said the ECB.

It will also allow banks to offer additional early repayment dates at no cost.

Pictet Wealth Management’s head for macroeconomic research Frederik Ducrozet said in a tweet that the decision to modify the terms of the loans retroactively was the “most radical, and the most dangerous of all options.”

Analysts warn that retroactive changes could discourage banks from tapping similar loans in future crisis situations.

The Euro zone banks have 2.1 trillion euros ($2.1 trillion worth) of TLTRO loans at negative or ultra-low interest rates. This is at a time when persistently low inflation was the main concern.

The ECB’s commercial bank deposit rate is currently in positive territory, and it is expected to rise.

According to estimates by IESEG School of Management, banks could make a guaranteed profit of between 30-35 billion euros just by parking their TLTRO cash with the ECB. This is based on the rate of deposits peaking at 2.5% and 4.5%.

Similar to the previous decision, the ECB decided that banks’ minimum reserves would be renumerated at its deposit rate, which was raised to 1.5% on Thursday, rather than at the main refinancing operation rate, which was increased to 2%.

The rates banks lend each other in the money market are still below the ECB policy rate. This means that the recent rate hikes have not been fully transferred to the banking sector.

Cash also creates more demand for low-risk securities. This limits the rise in rates of repurchase agreements as well as short-dated government bond yields.

After the decision, the Euro zone’s banking stocks temporarily fell but then performed better than the wider regional stock market. Investors are still waiting for details at 1345 GMT.

The spread between interest rate swaps (and the two-year German bond yield) fell to their lowest level since August. This is a sign traders see the move assisting with the shortage of German government bonds that are used as collateral in Europe.

($1 = 0.9997 euros)

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