ECB Tries to Prevent Banks from Profiting from Cheap Lending Scheme

The European Central Bank is seeking ways to prevent banks from earning billions of euros in additional profits from the favorable lending scheme it launched during the pandemic, as it plans to start raising interest rates in the second half of July.

As much as 2.2 billion euros in subsidized loans provided by the ECB to banks helped prevent a credit crisis due to the pandemic, but with the central bank now planning to raise rates, it is assumed that lenders in the eurozone will gain additional wealth estimated by analysts to be up to 24 billion euros. Hundreds of banks will be able to profit from subsidized loans simply by returning them to deposit at the central bank, and the ECB’s Governing Council is expected to discuss how to curb the additional margin, according to statements from sources close to the management.

Many argue that it would be politically unacceptable for the European Central Bank to allow banks to earn profits supported by taxpayers while increasing borrowing costs for households and businesses, as numerous commercial lenders further pay employees and distribute dividends to investors.

The ECB has announced an increase in the interest rate to -0.25 percent and hinted at further increases in September to raise the rate above zero for the first time in ten years, after which further increases could follow if inflation does not slow down.

One option could be for the ECB to change the terms of the loans to reduce banks’ ability to automatically return money, just as it made them more attractive after the pandemic began in 2020.

Up to 24 Billion Euros in Additional Profit

The central bank defended its cheap loans, stating that ‘without them, the pandemic would have hit the economy much harder,’ and declined to comment on how it will prevent lenders from generating unexpected profits.

From the financial firm Morgan Stanley, it was estimated that banks could earn between four and 24 billion euros in additional profits by the end of 2024, by depositing favorable loans at the central bank depending on the speed of rate growth in the coming months.

The European Central Bank estimated that the total profit available to banks was nearly half of Morgan Stanley’s maximum estimate, and more than 740 banks applied for loans in June 2020 when 1.3 billion euros were distributed. The total number of participants is not publicly available.

The ECB began offering loans known as targeted longer-term refinancing operations (TLTRO) in September 2019. Initially, they were available at an ECB interest rate of -0.5 percent, but after the pandemic was declared, the rate was reduced to -1 percent to encourage borrowing, provided that banks do not reduce their loan books.

TLTRO returned to its regular deposit rate last month, and importantly, the rate on loans is calculated as an average over their three-year lifespan. Banks can repay the money early every three months, and last month, early repayments of 74 billion euros were made, far less than expected, reflecting the increased attractiveness of the scheme as interest rates rise.

– We expect European banks to keep their TLTRO for as long as they can because it is just free money – said Fabio Ianno, a senior credit officer at the American firm Moody’s.

Banks Benefited from the Pandemic

From Morgan Stanley, it was calculated that if the European Central Bank raises its deposit interest rate to 0.75 percent by the end of this year, banks that took TLTRO loans in June 2020 could achieve a profit margin of 0.6 percent by the maturity of repayment in June 2023.

– This exchange has been quite profitable for us – said the CFO of a European bank, adding that it has been difficult for banks to talk about it because no one wants to say that they, as a bank, benefited from the pandemic.

And while the European Central Bank does not want to disclose data by bank, French lenders have been the biggest beneficiaries of cheap liquidity, followed by competitors from Italy and Germany.

In Germany, the largest lender is Deutsche Bank, whose interest income last year was boosted by nearly 494 million euros from subsidized liquidity from the central bank, accounting for 15 percent of its pre-tax profit.