ECB weighs options to limit banks’ gains from crisis loans

The European Central Bank (ECB) is searching for ways to stop lenders from profiting unduly as it raises interest rates to combat record inflation.

The issue concerns about €2.1 trillion ($2 trillion) of ultra-cheap loans, known as TLTROs, that were granted at the height of the pandemic to keep credit flowing and stave off deflation.

While the initiative was successful, it’s since become a thorn in the side of policymakers as banks can park the proceeds of the loans at the ECB and earn interest that exceeds their costs.

Doing so is becoming ever more lucrative as rates that were below zero as recently as July have risen to 0.75% and are expected to be doubled.

Such risk-free profits for banks look bad at a time when Europe’s energy crisis is sending household heating bills soaring and prompting some firms to curb production. But there are policy implications too: the steady source of income discourages early repayments that would help officials fight inflation. Euro-zone central banks could also post losses.

Estimates for how much lenders are currently benefiting vary. Economists at Morgan Stanley reckon they could be getting additional stimulus of almost €28 billion.

President Christine Lagarde said last month that parts of the ECB’s remuneration mechanisms must be revisited and will be reviewed “in due course.” Since then, officials have narrowed the debate over surplus cash being held at the ECB to three options.

Banks currently face interest equivalent to the average deposit rate over the life of the loan. The ECB could make this more expensive.

Changing contracts retroactively could pose legal challenges and jeopardise takeup at any future TLTRO offerings. But officials reckon those obstacles are surmountable because the case underpinning the agreements has vanished.

Indeed, credit to businesses is growing at almost 9% a year — the fastest pace since 2009. That’s threatening to stoke inflation that, at just short of 10%, is already five times the ECB’s medium-term target.

With an early-repayment deadline days before the ECB Governing Council’s December policy meeting, officials may push for a solution this week. Officials have signalled that waiting until the bulk of the loans — about €1.3 trillion — expires in June 2023 isn’t an option.

Another way of reducing payments to banks would be to make some deposits subject to a lower rate of interest, or no interest at all.

Known as reverse tiering, that would be the opposite of a strategy the ECB used to ease pressure on banks after it introduced negative rates in 2014. But the approach could also bring “unforeseen market consequences,” according to economists at BNP Paribas.

They include pushing the rate that financial institutions charge each other to lend unsecured overnight further below the deposit rate as cash is pulled from ECB accounts and placed elsewhere.

—Bloomberg