ECB to discuss blocking banks of multi-billion euro windfall as rates rise

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

The 2.2 billion euros in subsidized loans granted by the ECB to banks helped to avoid a credit crunch when the Covid-19 crisis hit. But with the central bank now planning to raise rates, it should provide an additional revenue bonanza worth up to €24 billion to eurozone lenders, analysts say.

The ECB’s governing council is due to discuss how it could cut the extra headroom hundreds of banks will be able to get from its subsidized loans by simply putting them back on deposit at the central bank, according to three people familiar with the plans.

People said it would be politically unacceptable for the ECB to provide banks with a taxpayer-backed profit as it raises borrowing costs for households and businesses and most commercial lenders pay bonuses to staff and distribute dividends to investors.

The ECB said it intended to raise its deposit rate to minus 0.25% at its July 21 meeting, while a larger increase in September is expected to take the rate 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 chances of banks getting an automatic return on the money, just as it made them more attractive after the pandemic hit in 2020.

The ECB defended its cheap lending to banks saying: “Without them, the pandemic would have hit the real economy much harder.” He declined to comment on how he could prevent lenders from making windfall gains.

Morgan Stanley estimated that banks could earn between €4 billion and €24 billion in extra profits by depositing the ECB’s cheap loans to the central bank from last month until the end of the program in December 2024 , partly a function of how quickly rates increase in the next few years. month.

A person briefed on the matter said the ECB had estimated the total gain available to banks to be almost half of Morgan Stanley’s maximum estimate. More than 740 banks applied for the loans at their peak in June 2020, when 1.3 billion euros were distributed, but the total number of program participants is not publicly available.

The ECB began offering the loans – known as Targeted Longer-Term Refinancing Operations (TLTROs) – in September 2019. Initially, they were available at the ECB’s deposit rate of minus 0.5%. But after the pandemic hit, the ECB cut the rate to minus 1%, effectively paying banks even more to borrow money, provided they didn’t reduce their loan portfolios.

The ECB cut the TLTRO rate back to its deposit rate last month. Importantly, the loan rate is calculated as an average over its three-year lifespan. Banks can prepay the money every three months. Last month, 74 billion euros in prepayments were made, far less than expected, reflecting the increased attractiveness of the scheme as interest rates rise.

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

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

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

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

Although the ECB does not break down data by bank, French lenders were the biggest users of cheap liquidity with exposure of nearly 500 billion euros in April, followed by their peers in Italy and Germany.

At Germany’s biggest lender, Deutsche Bank, the €44.7 billion in TLTRO borrowing was equivalent to about 9% of its overall loan portfolio of €481 billion.

Last year, Deutsche’s interest income was supported by 494 million euros thanks to subsidized liquidity from the ECB, or 15% of its pre-tax profit. Deutsche, which considers TLTROs a “government subsidy” on its accounts, declined to say how much was deposited with the ECB.

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

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