© Reuters. FILE PHOTO: Signage is seen outside the European Central Bank (ECB) building, in Frankfurt, Germany, July 21, 2022. REUTERS/Wolfgang Rattay/File Photo
FRANKFURT (Reuters) -The European Central Bank is studying ways of cutting a subsidy to banks that stands to cost it tens of billions of euros in interest, four sources told Reuters, in a move that is likely to attract a backlash from lenders.
To fight runaway inflation, the ECB has raised the rate it pays on the 4.6 trillion euros ($4.5 trillion) worth of banks’ reserves that exceed requirements from -0.5% to 0.75% in less than two months.
This leaves the ECB on the hook for tens of billions of euros in annual interest on those reserves and threatens to burn a hole in the capital of the central banks in countries where most of the those reserves sit, with the Netherlands and Belgium already warning about imminent losses.
It also puts the ECB in the politically uncomfortable position of subsidising banks at a time when the public is struggling amid high inflation.
Banks in particular stand to make a guaranteed profit on three-year loans they have taken out from the ECB itself because the average interest they pay on those Targeted Longer-Term Refinancing Operations (TLTRO) is lower than what they can earn by depositing that same cash at the central bank.
For these reasons ECB staff are examining ways to pay less, such as not paying interest on any cash that banks have borrowed from the central bank itself, the sources close to the matter told Reuters.
The ECB might also change the terms of TLTRO loans, although this would potentially damage the credibility of future programmes and invite legal challenges, the sources added.
Other proposals include only remunerating excess reserves below or above a threshold or scrapping interest on minimum reserves – those that banks have to keep at the ECB and which currently yield 1.25% a year, the sources said.
A spokesperson for the ECB declined to comment.
Any such move is likely to displease banks and might even land the ECB in court.
But ECB policymakers feel justified in taking action if that is needed to preserve capital, the sources said, noting that lenders had benefited from the ultra-cheap loans in the past.
Policymakers only briefly discussed this topic at their Sept. 8 meeting and are expected to revisit it at a retreat in Cyprus on Oct. 5 or at their policy gathering on Oct. 23 – when the ECB is set to raise rates again.
The Swiss National Bank said on Thursday it would only pay interest on reserves “up to a certain threshold” and French central bank governor Francois Villeroy de Galhau has also championed a similar plan.
One issue for the ECB is that different options would affect member countries in different ways.
Italian banks, for instance, have borrowed more from the ECB than they have deposited there in excess reserves, while the opposite is true for most other countries and especially for Germany, France and the Netherlands.
Dutch bank ING saw “disrupting effects on Italian money markets” if the ECB stopped remunerating part of the money borrowed by Italian banks under TLTRO.
Another problem is that the ECB has to justify any decision on monetary policy grounds, rather than to preserve its own profits or avoid political embarrassment.
“The more relevant issue in this regard, rather than our profit and loss statement, is the financial solidity of central banks’ balance sheets through their levels of capitalized reserves,” the Banque de France’s Villeroy de Galhau said in a recent speech.
“We have to think about a reserve remuneration system adapted to this new context.”
($1 = 1.0251 euros)