The European Central Bank studies creating a new interest rate

The European Central Bank (ECB) is studying the creation of a new interest rate, apart from the three major ones launched in 1998 when the monetary authority was launched.

According to sources familiar with the situation, the organization’s staff is considering establishing a mechanism to control the price of money in guaranteed overnight loans (repo market), after excess liquidity is causing the interest set on these operations are far from the marked references.

Until now, the Frankfurt-based institution has set the price of money through three benchmarks:

• The deposit rate (at 0.75%) is the level at which banks are paid for the liquidity they leave in the central bank’s piggy bank.
• The main refinancing rate (at 1.25%) is the interest at which it lends liquidity in its weekly auctions.
• The credit rate (at 1.5%) is the return that is required in exchange for lending in an extraordinary way.
• The new type would coexist with the previous three, and would be lower than the deposit rate.

Functioning

The operation would be carried out through the creation of a type known as “reverse repo” for operations with overnight guarantees.

If liquidity is achieved in the repo market by offering a sovereign bond or a similar high-quality asset as a pledge, under this new system the BCE It would take the excess liquidity of the market and offer collateral in exchange, paying a pre-fixed interest.

In this way, the monetary authority would establish a floor in the interests of this type of operation, since in general the banks would not be willing to cede their liquidity to firms less secure than the monetary authority, charging less for it.

The ECB preferred not to comment on the matter.

This movement is valued at the request of the institution’s advisers who make up the money markets working group at a meeting held on September 14. At that summit, the transcript of which was accessed by the Spanish newspaper Expansión, the ECB was warned that “the structural shortage of collateral in the market”, which is causing the transmission of interest rate increases to be “inefficient”.

The repo market does not include increases in ECB interest rates. When negative rates were abandoned, for example, these trades were still closing deep below 0%.”

The working group is made up of financial entities, among which are BBVA y CaixaBankand also large fund managers, such as Amundi o JP Morgan AMwhich advise the ECB on the evolution of the market and the most important events.

The new rate would have a cut similar to the one introduced by the Federal Reserve of the United States, which establishes a floor and a ceiling in the interest of these operations to prevent them from distancing themselves in excess of the price of money set at each meeting.

Alternative

The creation of a new interest rate is not the only option on the table to solve the problem of the scarcity of quality collateral and the depressed interest of operations in overnight loans.

The advisory group also proposes that the ECB directly issue debt certificates with its seal (ECB debt certificates) that serve to replace sovereign bonds as collateral. These artificial titles would multiply the volume of collateral available, reducing the gap between supply and demand.

Just as liquidity was increased to stimulate the economy, now the available collateral could be increased to balance the balance of supply and demand in guaranteed operations,” they point out from another entity.

The problems in the repo market go back a long way. The massive purchases of debt by the ECB, with which it sought to stimulate the economy, withdrew collateral from the market because even though formulas were enabled to lend those titles back, it is not enough. At the same time, the injections of liquidity to banking entities also unbalanced the other side of the balance.

This situation, common in developed economies, is accentuated in Europe because only part of the sovereign bonds, those with the highest credit rating, serve as collateral of the highest quality.

Given the scarcity of guarantees and the low demand for liquidity, the remuneration of these operations is rock bottom, limiting the ECB’s ability to tighten financing conditions. And the situation may get worse. The European body is evaluating how to cut the remuneration of excess liquidity in banking – what is known as profits from heaven – which have increased with the rise in rates. If this is carried out without taking measures such as the introduction of the new rate, the banks will transfer part of the trillions of liquidity to the repo market, affecting interest and clogging the monetary pipes.