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ECB discusses preventing banks from taking in billions of euros as interest rates rise

The European Central Bank is looking to prevent banks from making billions of euros more in profits from the super-cheap lending scheme it launched during the pandemic when it begins raising interest rates later this month.

The €2.2 billion in subsidized loans the ECB provided to banks helped prevent a credit crunch as the Covid-19 crisis hit. But with the central bank now planning a rate hike, it is set to provide up to 24 billion euros worth of additional income to eurozone lenders, according to analysts. accumulate.

The ECB’s Governing Council is expected to discuss how it could be possible to limit how much additional profits hundreds of banks can make on subsidized loans by placing them back on bank deposits. central bank, according to three people familiar with the plan.

People say it would be politically unacceptable for ECB to give banks a taxpayer-supported return while it is increasing borrowing costs for households and businesses and most commercial lenders are paying bonuses to employees. members and distribute dividends to investors.

The ECB has said it intends increase its deposit interest to minus 0.25% at the meeting on July 21, while signaling a larger increase is likely in September to bring the rate above zero for the first time in a decade, then further if Inflation remains high.

One option could be for the ECB to change the terms of the loans to reduce the chances of banks having automatic withdrawals, as well as making them more attractive after the pandemic begins in 2020. 2020.

The ECB has defended its cheap loans to banks, saying: “Without them, the pandemic would have hit the real economy much harder.” It declined to comment on how it might prevent lenders from earning the expected returns.

Morgan Stanley estimates banks could make between €4 billion and €24 billion more in profit by putting cheap ECB loans into central bank deposits from last month until the end of the scheme in June. December 2024, partly depending on the pace of interest rate increases in the near term. month.

One person briefed on the matter said that the ECB’s estimate of total gain for banks is close to half of Morgan Stanley’s maximum estimate. More than 740 banks applied for loans peaked in June 2020, when 1.3 billion euros were distributed, but the total number of participants in the program is not publicly available.

The ECB started providing loans – so-called targeted long-term refinancing operations (TLTRO) – in September 2019. They are initially available with the ECB deposit rate of minus 0.5%. But after the pandemic hit, the ECB cut interest rates to minus 1%, so banks will pay more to borrow money, as long as they don’t shrink their loan books.

The ECB paid the TLTRO interest on deposit rates last month. But importantly, the interest rates on loans are calculated as an average over their three-year life. Banks can repay loans early every three months. Last month, 74 billion euros in early repayments were made, much less than expected, reflecting the attractiveness of the scheme as interest rates rise.

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

“We expect European banks to keep their TLTROs for as long as possible because it’s just free money,” said Fabio Iannò, a senior credit officer at Moody’s. He predicts most of the ECB’s liquidity will not fund loans but be deposited at the central bank.

Morgan Stanley calculates that if the ECB raises its deposit rate to 0.75% by the end of the year, a bank lending TLTRO in June 2020 could earn a profit margin of 0.6% on the amount. it until it is due. refunded in June 2023.

“This transaction has been quite profitable for us,” said the CFO of a European bank. “It’s very hard for banks to shout about it – you don’t want to say that, as a bank, you’re benefiting from the pandemic.”

While the ECB does not release banks’ data, French lenders are the biggest users of cheap liquidity with a profit of almost 500 billion euros in April, followed by their peers in Europe. Italy and Germany.

At Germany’s largest lender Deutsche Bank, TLTRO’s €44.7 billion loan is equivalent to about 9% of the bank’s total of €481 billion in loans.

Last year, Deutsche’s interest income raked in €494 million from the ECB’s subsidized liquidity, or 15 percent of its pre-tax profits. Deutsche, which counts TLTRO as a “government subsidy” on its accounts, declined to say how much was deposited into the ECB.

A person familiar with the bank’s decision-making said “transfer against cash is not the purpose of joining Deutsche Bank’s TLTRO”.

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