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ECB Policymakers Review Interest on Government Cash Deposits to Tackle Mounting Losses

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The European Central Bank (ECB) is considering cutting the interest it pays on government cash deposits in an effort to address mounting losses resulting from its fight against inflation. The ECB and the eurozone’s 20 central banks have reported significant losses after raising interest rates on deposits to curb lending and price growth in the region.

At a policy meeting last Thursday, the eurozone’s central bankers discussed the remuneration of government deposits but decided to postpone any decision due to concerns that a change could have unintended consequences. There is a worry that reducing the interest paid on public cash deposits could lead governments to switch to commercial banks, which could then deposit the money back at the ECB for even higher remuneration.

This issue is expected to be reviewed again next year when the ECB will also address the broader issue of excess cash within the banking system. Currently, the ECB has set a ceiling on the remuneration of government deposits at eurozone central banks, based on the Euro Short-Term Rate (€STR) minus 20 basis points. Some national central banks, such as the Bundesbank, have already lowered their own rates to zero.

In recent months, government deposits at central banks in the eurozone have decreased from €647 billion ($683 billion) in July 2022 to €205 billion currently. Traditionally, governments did not earn interest on their cash balances at central banks due to an ECB ban on financing public coffers. However, the ECB’s purchases of government bonds and the increase in interest rates have complicated this situation.

The ECB began remunerating government deposits in September 2022 to prevent a sudden outflow of public cash into the money market, which had been deprived of collateral by the ECB’s own bond purchases. This decision is now facing criticism and scrutiny, as commercial banks have seen their profits soar due to the high interest rates set by the ECB. Some governments, including those of Lithuania, Spain, and Italy, have even imposed taxes on these banks.

While eurozone governments have benefited from the ECB’s bond purchases in recent years, they may have to bear the full cost if their central banks require a bailout in the future. The Dutch National Bank has warned about this possibility. Additionally, commercial banks in the eurozone earn 4.0% on the excess cash they deposit at their central bank, which amounts to a massive €3.5 trillion. This poses a financial challenge for central banks across wealthy countries, including the ECB, the Swiss National Bank, the Federal Reserve, and the Bank of England, which are all reporting losses.

ECB President Christine Lagarde stated last week that the central bank does not aim to show profits or cover losses. However, the issue of mounting losses is becoming increasingly political, particularly as commercial banks continue to benefit from high interest rates while governments may face the burden of potential bailouts. The debate surrounding the remuneration of government deposits remains a key concern for policymakers as they search for solutions to address the challenges posed by inflation and mounting losses in the eurozone’s banking system.

More detail via Reuters here… ( a )

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