Thread by @VincentWelsch

A barely known fact when it comes to the @ECB's recent interest rate hikes: Banks are now being subsidized for doing nothing.

Yes, read that again: Commercial banks connected to the #Eurosystem GAIN interest by NOT lending their money!

A 🧵 on why that is and why it's dumb.

The ECB's monetary policy toolbox comprises, among other things, three dedicated interest rates:
1. The Main Refinancing Operations (MRO) rate, currently at 1.25%
2. The rate of the Marginal Lending Facility, currently at 1.5%
3. The Deposit Facility rate (DFR), now at 0.75%

The former two rates apply when banks acquire loans from the ECB and have to pay interest on those loans. These have never been below 0%.

The latter rate, as the name suggests, applies on the money (excess reserves) a bank deposits at the ECB, i.e. money not used otherwise.

The term "excess reserves" refers to the money a bank holds with the ECB above the threshold of the Minimum Reserve Requirement (MRR). The MRR is defined as 1% of a bank's customer deposits. In other words, all money reserves in excess of the MRR are considered excess reserves.

A bank can place its excess reserves in the Deposit Facility, where it then gets remunerated at the DFR.

Excess reserves in the Euro Area's banking sector currently total around €4.6bn, with the vast majority of funds being held in the Deposit Facility.

ℹ️=*️⃣+(⏺️-(⏹️+🔼))

For the longest time, the DFR had been in sub-zero territory in order to incentivize banks to steer their money towards productive investment, making it fight #deflation instead of letting it idle.

(Whether that strategy worked or not is a whole different subject by the way.)

However, while the DFR was still negative, generous allowances were granted by the ECB (two-tier system) which protected a huge chunk of a bank's excess liquidity from incurring losses through the DFR.

Now that the DFR is back in positive territory, banks can rejoice again!

A DFR of 0.75% means nothing else than that banks get credited 0.75% of their excess reserve holdings p.a. by the ECB. Essentially, it amounts to the ECB handing out FREE MONEY to banks in exchange for NOTHING.

Or, to be more precise, rewarding the banks for not doing anything.

Not only is this practice extremely cynical imho, because banks are getting pampered while concepts like helicopter money for ordinary citizens remain within the realm of dreams.

It also distorts competition in banking, since large banks with the most reserves benefit the most.

But the main issue is the economic reasoning behind the DFR hike above 0% in the first place: When doing nothing is made a lot more attractive for banks than lending their money to the real economy, economy activity at large is expected to go down, and with it #inflation.

In this sense, the DFR represents the lowest threshold of interest any bank in the Euro Area will be accepting when negotiating new loan agreements with private sector entities, as well as for premiums/yields in Euro Area sovereign bond markets.

The ECB's decision to hike interest rates thus makes refinancing conditions for Euro Area member states, companies and households significantly harder. It will likely contribute to bringing down aggregate demand, but what for? Supply-side causes for inflation won't be affected!

This kind of ill-advised monetary policy only helps the managers and shareholders of too-big-to-fail European banks, while ruining the economy and impoverishing wide swaths of Europe's population in the process.

ECB interest rates, especially the DFR, must be set back to zero!

EDIT: Euro Area excess liquidity stands at €4.6tn, not €4.6bn of course. My Germaness really shines through here. 🙄