Eurozone bonds and bank stocks fell on Monday after the Financial Times reported that the European Central Bank is looking at ways to end what has effectively been a long-running subsidy for the banking sector.
The FT said the ECB is looking at ways to stop banks from putting their excess liquidity on deposit at the ECB at a higher rate than that at which they borrow from it through the so-called TLTRO window. That configuration has been in place since before the pandemic, but the spread widened during the pandemic as the ECB took even more dramatic steps to support a sector whose profitability had suffered from years of official Eurozone interest rates being below zero.
Targeted Long-Term Refinancing Operations, or TLTROs, have been the ECB’s preferred way of pushing cheap money into the financial system since former President Mario Draghi introduced them nearly a decade ago. During the pandemic, the amount lent through this facility peaked at 2.2 trillion euros ($2.3 trillion). The current terms of the TLTRO allow banks to borrow at rates as low as -1.05%, some 55 basis points below the deposit rate. The ECB is set to raise its deposit rate by 25 basis points in July and at least another 25 basis points in September, potentially widening that spread.
However, the FT reported that officials within the ECB thought it politically difficult to allow banks to keep making profits in such a way at a time when record-high inflation is reducing real income levels across the currency union. It didn’t give any details as to how it intended to do this. However, in the past, it has used changes to its collateral framework to effectively manage the amount banks can borrow from it. In recent weeks, the ECB has already tightened its collateral rules, which, together with expectations of rising rates, has led to less use of both the bank’s lending and deposit facilities. Its total balance sheet size, meanwhile, is peaking due to the end of its net bond purchases last week.
The report hit bond markets across the region, on the perception that lower demand for ECB funding will mean lower demand for the bonds that banks use as collateral. Yields on the German 10-Year benchmark rose by eight basis points to 1.32%, while the analogous Italian 10-Year yield rose by 12 basis points to 3.32%.
Italian banks have tended to use the ECB’s facilities more than any other Eurozone member states, and their stocks underperformed accordingly on Monday. By 5:30 AM ET (0930 GMT), Intesa Sanpaolo (BIT:ISP) stock was down 2.9%, while Banco Bpm (BIT:BAMI) stock was down 2.7%, and Bper Banca SpA (BIT:EMII) was down 2.1%. Unicredit (BIT:CRDI) was down 1.2%.
Other banks suffering included Portugal’s Banco Comercial Portugues (ELI:BCP), which fell 3.4%, and Spain’s Banco de Sabadell (BME:SABE), which fell 2.7%. European benchmark stock indices, however, were mostly higher.