BRUSSELS, 25 October 2022
European banks call on the ECB to avoid tightening the terms of the Targeted Longer-Term Refinancing Operations (TLTRO)
The European Savings and Retail Banking Group (ESBG) believes that tightening the TLTRO terms would have serious negative consequences for banks and for the European economy, in addition to implying high legal risks for the European Central Bank (ECB) itself. In our view, a more viable and balanced solution to address the interest rates hike would be the introduction of a reverse tiering system, which was already successfully applied in 2019.
Press reports suggest that the ECB is considering a tightening of the TLTRO terms at its next policy meeting on 27 October 2022. In light of the quick and big rate hikes, the ECB aims to contain the interest costs to be paid to banks that park excess liquidity at the central institution. However, this move could imply serious negative consequences for banks and for the economy.
TLTRO loans were first issued in 2014 to encourage banks to lend as Europe’s debt crisis weighted on economic growth and threatened to trigger deflation. A second series (TLTRO II) was announced in 2016 and a third series (TLTRO III) in 2019. Through these operations, the ECB offers longer-term loans to banks at favourable costs and encourages them to lend to businesses and consumers in the euro area. This keeps borrowing costs low and supports spending and investments.
Several options are reportedly being discussed by ECB officials including a unilateral change of the TLTRO terms, where cash deposit from banks at the ECB would not be remunerated at the ECB deposit rate. This would not only be very damaging for banks and for the economy, but it would also imply high legal risks for the ECB.
More specifically, two potential negative effects should be highlighted
Exacerbate country risk premia: The excess liquidity in the euro area is unevenly distributed across jurisdictions. Changing the terms of the TLTRO would disproportionately impact countries with high TLTRO drawings, relative to excess liquidity. This, in turn, would exacerbate a potential increase in risk premia in these countries.
Hedges and risk management operations would lose effectiveness: Some banks may have hedged the interest rate risk embedded in the TLTRO terms. A change in the term sheet would therefore directly and immediately impact the P&L and could imply significant losses for some banks.
Policy suggestion to mitigate these effects
ESBG believes that a more viable and balanced solution would be the introduction of a reverse tiering system. A two-tier system was already successfully applied in 2019 when the deposit facility was negative, in that case to avoid banks paying too much interest on excess liquidity. It is therefore a system which has already been tested.
The reverse tiering consists in applying a tiering multiplier for the remuneration of excess reserves, maybe coupled with liquidity absorbing operations (e.g. through central bank issuances of debt certificates), which would also allow for managing excess liquidity in the euro area, but with less potential disruption compared to changing the terms of the TLTRO. When introduced, an adequate calibration of such a measure should also be mindful and contribute to avoid undue effects on the transmission of monetary policy.
ESBG and its members are sure that the ECB will take into consideration the interest of the European economy and will be able to find the most suitable solution in the face of the ongoing crisis.
About the ESBG
The European Savings and Retail Banking Group (ESBG) has 21 members in 17 countries. As some of its members are national organisations, ESBG represents the interests of over 800 banks working responsibly and closely with their communities and SMEs. Together, ESBG members manage assets worth €5,700 billion, serve 162 million Europeans and employ nearly 660,000 people. ESBG is the regional arm of the WSBI. Both organisations are headquartered in Brussels. Website: https://www.wsbi-esbg.org/