The European Central Bank is looking at ways to stop banks earning billions of euros of extra profit from the ultra-cheap lending scheme it launched during the pandemic once it starts to raise interest rates later this month.
The €2.2tn of subsidised loans provided by the ECB to banks helped to avert a credit crunch when the Covid-19 crisis hit. But with the central bank now planning to raise rates it is set to provide a bonanza of extra earnings worth up to €24bn for eurozone lenders, according to analysts.
The ECB’s governing council is due to discuss how it could curb the extra margin that hundreds of banks will be able to earn from its subsidised loans by simply placing them back on deposit at the central bank, according to three people familiar with the plans.
The people said it would be politically unacceptable for the ECB to provide banks with a taxpayer-backed profit while it is raising borrowing costs for households and businesses and most commercial lenders are paying bonuses to staff and distributing dividends to investors.
The ECB has said it intends to raise its deposit rate to minus 0.25 per cent at its meeting on July 21, while signalling a bigger raise is likely in September 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 chance for banks to make an automatic return on the money, just as it made them more attractive after the pandemic began in 2020.
The ECB 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 could stop lenders making windfall gains.
Morgan Stanley estimated banks could earn between €4bn and €24bn of extra profit by putting the ECB’s cheap loans on deposit at the central bank from last month until the end of the scheme in December 2024, depending partly on how fast rates rise in the coming months.
One person briefed on the matter said the ECB estimated the total gain available to banks was almost half the maximum estimate by Morgan Stanley. More than 740 banks applied for the loans at their peak in June 2020, when €1.3tn was distributed, but the total number of participants in the scheme is not publicly available.
The ECB started offering the loans — known as targeted longer-term refinancing operations (TLTRO) — in September 2019. Initially they were available at the ECB’s deposit rate of minus 0.5 per cent. But after the pandemic hit, the ECB cut the rate to minus 1 per cent, in effect paying banks even more to borrow money, provided they did not shrink their loan books.
The ECB returned the TLTRO rate to its deposit rate last month. But crucially, the rate on the loans is calculated as an average over their three-year life. Banks can repay the money early every three months. Last month €74bn of early repayments 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 ditched the idea of repaying them early,” said one official.
Fabio Iannò, a senior credit officer at Moody’s, said: “We expect European banks to hold on to their TLTROs as long as they can because it’s just free money.” He predicted the bulk of ECB liquidity would not fund loans but be deposited at the central bank.
Morgan Stanley calculated that if the ECB raised its deposit rate to 0.75 per cent 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 per cent 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 difficult for banks to shout loudly about it — you don’t want to say that, as a bank, you were benefiting from the pandemic.”
While the ECB does not break out the data by banks, French lenders were the biggest users of the cheap liquidity with an exposure of close to €500bn in April, followed by their peers in Italy and Germany.
At Germany’s largest lender Deutsche Bank, the €44.7bn of TLTRO borrowing was equivalent to some 9 per cent of its overall €481bn loan book.
Last year, Deutsche’s interest income was buoyed by €494mn from the subsidised ECB liquidity, or 15 per cent of its pre-tax profit. Deutsche, which counts TLTROs as a “government grant” on its accounts, declined to say how much was deposited at the ECB.
A person familiar with the bank’s decision-making said “a carry trade versus cash was not the purpose of Deutsche Bank’s TLTRO participation”.