Tough Choices On TLTROs Today (1/2)

As MNI's Policy Team reported Tuesday, their sources expect the ECB's Governing Council to approve a proposal today to retroactively modify conditions to TLTRO loans.

• Such a move would be aimed at incentivising early TLTRO repayments, with the overarching goals to a) reduce banks' subsidized return from borrowing via TLTRO and earning the ECB deposit rate b) reduce excess liquidity / the size of the ECB balance sheet as the Governing Council moves further toward normalising policy.
• The ECB pays E30-40bln annually and rising in this "carry trade". The majority (est E1.3trn of the E2.1trn outstanding) of TLTRO III loans are due to be paid back in June 2023, with the next voluntary repayment date coming up in December 2022.

Here are the likely options - essentially the ECB can change the cost of borrowing, or the rate of remuneration:

• The ECB could decide that TLTRO borrowing rates will rise in closer lockstep with deposit rates, eliminating the spread widening during the hiking cycle and increase incentives to repay TLTROs early. Currently, banks borrow TLTRO funds at the average depo rate over the life of the TLTRO loan. This means that as the ECB raises the deposit rate, the average borrowing rate remains relatively low, and banks earn the widening spread. That difference is becoming especially pronounced now that the ECB is hiking in 75bp increments.
  
• Increasing the cost of TLTROs by adding a spread over the average borrowing rate. This would be a fairly blunt approach but would probably be a stronger incentive for early TLTRO repayment.
• A reduction in the rate that banks can receive when parking TLTRO cash in the deposit facility. This could be a flat rate (0%) or one that is linked to an existing rate - for example, the minimum reserve rate (currently 0.5%, below the 0.75% deposit rate).
• Limiting the proportion of bank deposits that can earn the ECB's deposit rate.The ECB could for instance establish a multiplier on TLTRO lending vs required reserves, with reserves above those required earning a lower rate. would be a so-called "reverse tiering" that would probably encourage banks to reduce their uptake of the TLTRO-Depo arbitrage.