ECB Reviews Interest on Government Deposits to Curb Losses – Sources, By Reuters

By Francesco Canepa

FRANKFURT (Reuters) – Policymakers at the European Central Bank (ECB) are currently evaluating the interest rates paid on government cash deposits, including the possibility of a reduction, aimed at addressing increasing losses incurred during the battle against inflation, according to two sources familiar with the situation.

The ECB and the 20 central banks of eurozone countries have begun reporting significant financial losses after raising interest rates on deposits to historical highs in an effort to curb lending and control price growth within the euro area.

To mitigate these interest payments, central bankers in the eurozone revived discussions regarding the remuneration of government deposits during their recent policy meeting. However, they postponed any decisions after initial deliberations, concerned that adjustments could lead to unintended consequences, the sources indicated.

There are concerns that lowering interest rates on public cash might prompt governments to shift their funds to commercial banks, which could then return those deposits to the ECB for even greater returns.

An ECB spokesperson opted not to provide any comments on the matter.

Policymakers are expected to reevaluate this issue next year, coinciding with plans to address the broader challenges posed by surplus liquidity in the banking system. Earlier in the year, the ECB established a cap on the interest for government deposits in eurozone central banks, set to the Euro Short-Term Rate (currently at 3.9%) minus 20 basis points.

Certain national central banks, including the Bundesbank, have already adjusted their rates down to zero, following the country’s reputation as a safe haven for public funds.

Meanwhile, government deposits at central banks in the bloc have drastically declined from 647 billion euros in July 2022 to 205 billion euros in the most recent accounts.

Traditionally, governments have not earned interest on their balances at the central bank, adhering to an ECB policy against financing public budgets. However, years of ECB bond purchases, combined with the recent spike in interest rates, have complicated this understanding.

In September 2022, the ECB raised its rate for commercial banks’ deposits above zero. In response to concerns about “an abrupt outflow” of public cash into the money market—depleted of essential collateral due to the ECB’s own bond purchases—the central bank began to offer remuneration for government deposits as well.

The financial implications are accompanied by political considerations. Commercial banks have flourished due to the ECB’s elevated interest rates, leading to public backlash and proposed taxes from governments in various countries.

While eurozone governments have benefited somewhat from these developments, they may ultimately bear the consequences if their central banks require a bailout in the future. The excessive cash reserves held by eurozone commercial banks are earning 4.0% interest, totaling an incredible 3.5 trillion euros, following a decade of monetary expansion through significant bond purchases aimed at boosting insufficient inflation.

In contrast, governments had previously enjoyed sizeable returns from their central banks due to those same bond acquisitions.

ECB President Christine Lagarde stated last week that the central bank’s goal is not to generate profits or cover losses, confirming that there has not yet been a discussion about increasing the portion of banks’ unremunerated reserves.

This issue is not unique to the ECB, as central banks in other affluent nations are also facing similar challenges. For instance, the Swiss National Bank recently decided to reduce the interest payments to commercial banks, with both the Federal Reserve and the Bank of England also experiencing losses.