On Thursday, the European Central Bank will raise interest rates for the eighth time in a row. After that it could soon be over, because experts expect that the summit will be reached in summer. The key interest rate is currently 3.75 percent, a further increase of 0.25 percentage points is considered likely. The central bank has made the fastest turnaround in interest rates in its history – in July 2022 the key interest rate was still zero percent.
Europe’s banks are a big beneficiary of the tight monetary policy. The credit institutes now receive an interest rate of 3.25 percent on their deposits at the central bank – that is more than German government bonds yield. At the same time, the banks only pass on trace elements of the interest rate advantage to their customers – and the financial sector was able to make a profit from monetary policy even when interest rates were zero. The debate as to whether the central bank is subsidizing the banking sector at the taxpayer’s expense is therefore gaining momentum. The citizens’ movement Finanzwende estimates the benefit for the banking sector at 36.6 billion euros in a current calculation.
“The ECB has already subsidized the banks in the low-interest phase, now, in the high-interest phase, it would be time to skim off this money again. But the opposite is happening. The banks are also benefiting now,” says Michael Peters, an expert at Finanzwende. A subsidy exists when the central bank lends money below market interest rates or pays interest above the reference interest rate. In this way, banks could generate income without risk. Peters has identified three such revenue opportunities:
Firstly, through the TLTRO loan program worth billions of euros: Between June 2020 and June 2022, banks were able to borrow money cheaply from the ECB and then park this amount profitably with the central bank again. The ECB actually wanted to stimulate the economy, because banks could only benefit from the low interest rates if they granted sufficient loans to the economy. But was that necessary? The bottom line is that large borrowers in particular are likely to have benefited and not so much small and medium-sized companies. According to the Finanzwende, the interest rate difference brought the banks a plus of around 20.5 billion euros.
Secondly, through exemptions: Between December 2019 and July 2022, the interest rate for bank deposits at the ECB was minus 0.5 percent. After much lamentation from the industry, the ECB introduced an exemption on which this negative interest did not have to be paid. “Since the credit institutions could get money on the market at negative interest rates, they got extra money there and deposited it with the central bank in order to take full advantage of the exemption amount,” says Peters. The interest rate difference at the expense of the central bank brought a plus of around 11.6 billion euros.
Thirdly, about the high interest on the minimum reserve: The banks have to deposit money with the ECB as a so-called minimum reserve. For many years, this reserve has yielded higher interest rates than the financial markets offered. “This interest rate difference was also a subsidy,” says Peters, who estimates the amount in the years 2014 to 2022 at around 4.5 billion euros. The figures, which the ECB did not want to comment on, are an estimate because the details of the transactions are very complicated to trace.
“The banks have passed the negative interest rates on to their customers to a greater extent than they are now doing with the positive interest rates.”
The European Parliament is now also dealing with the issue. In the most recent hearing, a member of parliament confronted ECB President Christine Lagarde with the question of whether the central bank was being too generous towards the banks. The Frenchwoman replied that the ECB is responsible for price stability and that high interest rates are “a by-product of the monetary policy measures that we have to take”. Inflation in the monetary union was 6.1 percent in May. This is less than in the previous months, but is still well above the target of two percent of the monetary authorities.
Economist Paul de Grauwe already criticized the preference given to the banking sector in January. “The ECB will pay out 92 billion euros to banks this year,” said de Grauwe in one Article for the Center for Economic Policy Research. This money, which comes from the high interest rates on deposits, escapes the state budgets to which the ECB distributes its profits every year.
Naturally, Europe’s banks see things differently. For years they have criticized the ECB for its zero and negative interest rate policy. Credit institutions had to pay negative interest on their deposits at the central bank. The institutes passed part of these costs on to the customers, and the ECB later granted the aforementioned allowances. “The banks have passed the negative interest rates on to their customers more than they are now doing with the positive interest rates,” says Peters, an expert on the financial transition. In addition, German banks would earn around 27 billion euros this year from the high interest rates on deposits.