ECB seeks to cut bank subsidies as rate hikes leave it hanging, sources say

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Signage is seen outside the European Central Bank (ECB) building in Frankfurt, Germany July 21, 2022. REUTERS/Wolfgang Rattay/File Photo

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  • Banks should make guaranteed profits on ECB loans
  • The ECB could reduce remuneration and modify the conditions
  • The banking lobby defends the current conditions

FRANKFURT, Sept 23 (Reuters) – The European Central Bank is exploring ways to cut a subsidy to banks that is expected to cost it tens of billions of euros in interest, four sources told Reuters, prompting lenders to react.

To combat runaway inflation, the ECB raised the rate it pays on the 4.6 trillion euros ($4.5 trillion) in banks’ reserves that exceed requirements from -0.5% to 0, 75% in less than two months.

This leaves the ECB on the hook for tens of billions of euros in annual interest on these reserves and threatens to burn a hole in the capital of the central banks of the countries where most of these reserves are located, the Netherlands and Belgium already warning of impending losses.

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It also puts the ECB in the politically uncomfortable position of subsidizing banks at a time when the public is struggling amid high inflation.

Banks, in particular, are likely to make a guaranteed profit on the three-year loans they have taken out from the ECB itself, because the average interest they pay on these targeted long-term refinancing operations (TLTRO) is less than what they can earn by depositing that same cash in the central bank.

For these reasons, ECB staff are exploring ways to pay less, such as not paying interest on cash that banks have borrowed from the central bank itself, sources familiar with the matter told Reuters.

The ECB could also change the terms of TLTRO loans, although this would potentially damage the credibility of future programs and invite legal challenges, the sources added.

Other proposals include remunerating only excess reserves below or above a threshold or abolishing interest on required reserves – those which banks must keep at the ECB and which currently earn 1.25% per year, the sources said.

An ECB spokesman declined to comment.

The sector body of the European Banking Federation has defended the existing and favorable conditions of the TLTRO, which were set by the ECB at the height of the coronavirus epidemic.

“The TLTRO program and its terms were put in place as European banks took risks to keep the economy afloat during the COVID pandemic,” it said in a statement.

But ECB policymakers feel justified in taking action if necessary to preserve capital, the sources said, noting that lenders have benefited from ultra-cheap loans in the past.

Policymakers only briefly discussed this topic at their meeting on September 8 and are expected to return to it during a retreat in Cyprus on October 5 or at their policy meeting on October 27 – when the ECB is expected to raise again. its rates.

The Swiss National Bank said on Thursday it would only pay interest on reserves “up to a certain threshold” and French Central Bank Governor Francois Villeroy de Galhau also championed a similar plan.

A problem for the ECB is that different options would affect member countries in different ways.

The Italian banks, for example, have borrowed more from the ECB than they have deposited excess reserves there, whereas the reverse is true for most other countries and in particular for Germany, France and the Netherlands.

Dutch bank ING has seen “disruptive effects on Italian money markets” if the ECB stopped remunerating some of the money borrowed by Italian banks under the TLTRO.

Another problem is that the ECB must justify any decision on monetary policy grounds, rather than preserving its own profits or avoiding political embarrassment.

“The most relevant question in this respect, rather than our income statement, is the financial strength of central banks’ balance sheets through their levels of capitalized reserves,” Villeroy de Galhau of the Banque de France said in a recent speech.

($1 = 1.0251 euros)

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Reporting by Francesco Canepa, Frank Siebelt and Balazs Koranyi; Editing by Hugh Lawson and Mark Potter

Our standards: The Thomson Reuters Trust Principles.

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