European Central Bank to discuss preventing banks from making billions of euros in windfall profits as interest rates rise

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The European Central Bank is looking for ways to prevent banks from making 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 trillion euros in subsidized loans that the European Central Bank granted to banks helped to avoid the credit crisis when the Covid-19 crisis hit. But with the central bank now planning to raise interest rates, it should provide a wealth of additional profits of up to €24 billion to eurozone lenders, analysts said.

The Governing Council of the European Central Bank is set to discuss how it can limit the extra headroom that hundreds of banks will be able to draw from their subsidized loans once they return to deposits at the central bank, according to three people familiar with the plans.

People said it would be politically unacceptable for European Central Bank To provide banks with taxpayer-subsidized profits while increasing borrowing costs for households and businesses, most commercial lenders pay bonuses to employees and distribute profits to investors.

The European Central Bank has announced its intention to Increase the interest rate on deposits minus 0.25% at its July 21 meeting, while the signal for a bigger increase in September is expected to pass zero for the first time in a decade, followed by further increases if inflation remains elevated.

One option could be for the European Central Bank to change lending terms to reduce the risk of banks automatically returning funds, just as it made them more attractive after the pandemic hit in 2020.

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

Morgan Stanley has estimated that banks could make between 4 and 24 billion euros in additional profits by placing cheap ECB loans in central bank deposits from last month until the end of the program in December 2024, partly based on how quickly rates will generate interest in the near future. month.

A person familiar with the matter said the ECB estimated the total gains available to banks to be around half of Morgan Stanley’s maximum estimate. More than 740 banks applied For loans at their peak in June 2020, when 1.3 trillion euros were distributed, but the total number of program participants is not publicly available.

The European Central Bank has started making loans – known as Targeted Long-Term Refinancing Operations (TLTROs)TLTRO) – in September 2019. Initially, it was available at the ECB deposit rate of 0.5%. But after the pandemic hit, the European Central Bank lowered the interest rate to -1%, effectively paying banks more to borrow money, provided they did not reduce their loan portfolios.

The European Central Bank cut the TLTRO rate back to the deposit rate last month. But above all, the loan rate is calculated on average over its three years of life. Banks can repay the money as early as every three months. Last month, 74 billion euros in advance payments were made, far less than expected, reflecting the growing attractiveness of the system as interest rates rise.

“Some banks have reviewed their profit and loss accounts with the European Central Bank, then abandoned the idea of ​​reimbursing them early,” explained one of the officials.

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

Morgan Stanley has calculated that if the European Central Bank raises the deposit rate to 0.75% by the end of this year, the bank that took out the TLTRO loan in June 2020 could make a profit margin of 0.6% on the money until it matures. . It is payable in June 2023.

“This trade has been very profitable for us,” said the chief financial officer of a European bank. “It’s been hard for the banks to shout loudly about this – you don’t mean you as a bank have profited from the pandemic.”

While the European Central Bank does not separate the data by bank, French lenders were the biggest users of cheap cash with exposure of nearly 500 billion euros in April, followed by their Italian and German counterparts.

At Deutsche Bank, Germany’s largest bank, TLTRO’s borrowings of €44.7 billion were equivalent to about 9% of its total loan portfolio of €481 billion.

Last year, Deutsche’s interest income was boosted by 494 million euros thanks to liquidity guaranteed by the ECB, or 15% of its pre-tax profits. Deutsche, which views the TLTRO as a “government subsidy” on its accounts, declined to disclose the amount deposited with the ECB.

“Mobile commerce for cash was not the goal of Deutsche Bank’s TLTRO engagement,” said a person familiar with the bank’s decision-making process.

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