ECB has little space to save its wallet from a damaging monetary experiment
The European Central Bank has to announce specific measures on Thursday to limit some remarkable profits of commercial lenders.
Either that or the ECB will have to bear the damage both in terms of money and credibility.
A program that offered cheap loans to banks, consisting in targeted longer-term refinancing operations (TLTROs), was thought of as a monetary experiment.
Through it, firms and households were supposed to have easier access to credit. The funding scheme carried zero risks for commercial lenders, who are paying an average interest rate of 0.1% and could pay 0.5% as rates rise this year.
Since 2014 on, banks borrowed about €2.1 trillion through this scheme. More than half – €1.2 trillion – are maturing in June 2023. But since BCE started hiking its policy rate, rising it from minus 0.5% in the summer to 0.75% now, lenders can make guaranteed profits.
Even more, markets expect a further rise of key interest rate to 1.5% on Thursday.
Since that’s higher than the TLTRO cost, lenders can put the money into their own accounts at BCE, taking advantage from the arbitrage.
The net cost for the ECB could reach to up to €70 billion if commercial lenders decide to use € 1.1 trillion for the risk-free trade.
Of course, the final cost for the central bank depends on what happens with rates.
BCE cannot raise the cost of TLTRO without forcing the legal boundaries of the contract he signed and agreed upon with lenders.
It would be a unilaterally and retroactively action and would discourage banks from using future schemes.
Euro zone countries that may still need cheaper money for their economy, like Italy and Greece, could face serious borrowing challenges if BCE is to charge higher interest on TLTROs.
So the space in which the central bank can take decisions becomes increasingly narrow. Since TLTRO users are making money through their deposits, BCE has an alternative in reducing the interest it is paying on them.
Another option would be to introduce a tiering system for the deposit facility rate, paying a lower rate above a certain threshold of funds deposited at the central bank.
But both these ideas would come at the expense of the ECB’s fight to reduce inflation.
Still, the central bank can always launch a new, arbitrage-proof funding scheme, if worried about Eurozone`s vulnerable economies.
When there’s a war and an energy crisis that threatens public finances, allowing banks to make risk-free profits at the expense of the ECB is unsustainable.