Why don't Eurozone banks repay TLTRO3s early?
Banks could make a bumper profit this year on TLTRO3s, despite the end of the favourable lending rate
The ECB experience with VLTROs in 2013 was early repayment and a pro-cyclical shrinkage of the Eurosystem balance sheet and liquidity—tightening monetary conditions;
Now that the TLTROs from the pandemic also have the opportunity for early repayment, this could once more complicate policy-making at a time the Governing Council is planning rate increases;
Fortunately for the banks, due to the technical detail of the calculation of the rate charged for these repos in the year ahead, they could make an even larger profit over the year ahead than over the past two years if rates increase sharply—as they are likely to do;
As such, early TLTRO3 repayment makes no sense—and early ECB balance sheet shrinkage is unlikely.
This week saw the end of the favourable interest rate on the ECB’s Pandemic-related Targeted Long-Term Repo Operations (TLTRO3s) creating the possibility of Eurosystem balance sheet shrinkage already this year—at a time when other central banks are initiating their own QT through the roll-off of maturing bonds.
TLTROs are repo operations across the Eurosystem whereby the ECB provides euro liquidity to banks, in exchange for collateral, which can be used to make investments—or, as is the intention of this generation of repos, extend loans to corporates to support activity during the pandemic.
The terms of these TLTROs were particularly favourable: the “lending rate” was below the deposit rate. That is, “borrowing rates in these operations can be as low as 50 basis points below the average interest rate on the deposit facility”—meaning -100bps. So providing the banks met their lending targets—and most did—they were “paid” 100bps over the past 2 years for borrowing from the ECB. Paid to borrow!
TLTROs outstanding reached about EUR2.2 trillion during the pandemic, a large component of the balance sheet expansion across the Eurosystem at the height of the health emergency—larger than the Pandemic Emergency Purchase program (PEPP) for example.
Since the favourable interest rate has now expired, and banks can now voluntarily repay these repos, won’t the ECB balance sheet now contract sharply?