Arbitrage by banks depositing TLTRO funds at the ECB may prompt changes to reserve remuneration.
European Central Bank officials are uneasy with what some see as excessive profits for commercial banks generated by measures originally put in place to help lenders cope with the pandemic, and are likely to consider potential changes including the possible introduction of tiered remuneration on reserves, Eurosystem officials told MNI.
Discussions on reserve remuneration could start at the Governing Council’s non-monetary policy meeting to be held in Cyprus on Oct 5, though it is not currently believed to be on the official agenda. A tiering system would restrict the proportion of reserves benefiting from rising interest rates, with a view to limiting arbitrage by banks depositing cash provided to them at negative rates under the ECB’s pandemic era Targeted Long-Term Repurchase Operations.
“It is a situation that must be addressed at the earliest possible opportunity. We must look at the structure of rates remunerating reserves held at central banks,” an official at one national central bank told MNI.
An official from another central bank agreed, adding that it would be easier to discuss such a matters in a non-monetary policy meeting, which attracts less media attention. If the issue remains unaddressed, the public will eventually realise that banks are profiting disproportionately from ECB policy, the official said, adding that the problem was also a product of the differences between national financial systems given the failure to complete European banking union.
Addressing the use of cheap ECB loans for arbitrage should be the first and easiest point to consider, as it could prompt repayment of TLTRO funds, helping to shrink the ECB’s EUR8.75 trillion balance sheet.
Nonetheless, officials said there is still no consensus on how to proceed, with a likely outcome of the Cyprus gathering being that ECB technical committees could be tasked with preparing options for the Governing Council, which would take a decision before the end of the year.
But with liquidity and collateral issues coming to the fore, and only partially addressed by the temporary halt of a cap on remunerations paid on government deposits, policymakers understand decisions need to be taken fairly quickly.
Quantitative tightening is another subject set to come up for discussion for the ECB, but it is likely to be Q1 2023 before it becomes an active topic for debate at Governing Council meetings, and only once technical staff have reported back with a range of options.
An ECB spokesperson declined to comment.