FRANKFURT (Reuters) – The European Central Bank on Thursday got rid of a subsidy on its multi-year loans to banks to encourage them to repay them early, in a move designed to mop up excess cash from the system and avoid political embarrassment.
The ECB has come under pressure to change the terms of its Targeted Longer-term Refinancing Operations (TLTRO) because the generous rate offered at the height of the COVID-19 pandemic now allowed banks to make a guaranteed profit at the ECB’s expense.
As well as being costly for the ECB, this source of cheap cash was getting in the way of its fight to lower inflation, which is running at close to 10% in the euro zone.
For these reasons, the ECB said banks would now have to pay going rates on their TLTRO credit, rather than the average rate over the whole duration of the loans.
“From 23 November 2022 until the maturity date or early repayment date of each respective outstanding TLTRO III operation, the interest rate on TLTRO III operations will be indexed to the average applicable key ECB interest rates over this period,” the ECB said.
It will also offer banks additional voluntary early repayment dates.
Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, said in a Twitter post the decision to change the terms of the loans retroactively was “the most radical, and the worst of all options.”
Analysts have warned that retroactive changes could deter banks from tapping similar loans in future crises.
Euro zone banks are sitting on 2.1 trillion euros ($2.1 trillion) worth of TLTRO loans extended at ultra-low or even negative interest rates at a time when the ECB’s main worry was persistently low inflation.
But the deposit rate the ECB pays commercial banks is now back in positive territory and is likely to rise further.
That means banks could make a guaranteed profit of 30-35 billion euros simply by parking their TLTRO cash at the ECB, according to IESEG School of Management estimates based on the rate on deposits peaking somewhere between 2.5% and 4.5%.
In a similar vein, the ECB decided to renumerate banks’ minimum reserves at its deposit rate, which it hiked to 1.5% on Thursday, instead of at the main refinancing operations rate, which it hiked to 2%.
The rates at which banks lend to each other in the money markets are also still below the ECB’s policy rate, meaning its recent rate hikes have not been fully passed on to the banking sector yet.
The cash also creates additional demand for low-risk securities, limiting the rise in rates on repurchase agreements and short-dated government bond yields.
Euro zone banking stocks briefly fell following the decision but then outperformed the region’s broader stock market as investors await details to be released at 1345 GMT.
The spread between interest rate swaps and the two-year German bond yield fell to the lowest since August in a sign that trader see the move as helping ease the shortage of government bonds used as collateral in the euro area.
($1 = 0.9997 euros)
(Reporting By Francesco Canepa and Yoruk Bahceli; Editing by Catherine Evans and Hugh Lawson)
