What Are the Effects of the ECB’s Negative Interest Rate Policy?
25 PE 662.922
But apart from this, what could the ECB do to avoid or overcome the reversal rate problem (if it were
to materialise)? The ECB has actually introduced an innovative tool in recent years: the TLTROs. This
new type of refinancing operation has attracted less attention than other unconventional tools, such
as QE or its negative DRF, but we believe it could actually help overcome the reversal rate issue. With
the launch of the TLTRO III in March 2019
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, the ECB decided for the first time that the rate could be
negative and as low as the deposit facility rate (if some conditions were fulfilled in terms of lending
volume). In practice, this means that the banks resorting to TLTROs are paid to borrow from the ECB,
which partly compensates for the negative DFR on excess reserves.
At the start of the COVID-19 crisis, on 12 March 2020, the ECB went further and for the first time reduced
its TLTRO rate by 25 bps below the DFR, for banks fulfilling their lending benchmarks to the real
economy. On 30 April 2020, the ECB decided to further ease the conditions on its TLTROs by cutting
the applicable rate by a further 25 bps to as low as -1% (i.e. 50 bps below the DFR).
As discussed in Claeys (2020), making the level of the TLTRO rate independent from the DFR provides
a new way for the ECB to ease financing conditions. This allows the central bank to adopt a more
accommodative stance without having to cut its DFR further, thus avoiding its potential side effects.
Given that the rate is lower than what banks pay on their excess liquidity, this provides banks with a
strong incentive to borrow long-term from the ECB and to grant more loans. This, in turn, should
mechanically increase their reserve requirements, since these are calculated as a ratio of a bank’s
liabilities – mainly its customers’ deposits. Considering the new tiering system on reserve
remuneration, their exempted reserves would also be increased, even more than proportionally. This
ultimately should create a virtuous cycle for bank profitability and incentivise banks to lend to the
economy, despite negative policy rates (or more precisely thanks to a negative spread between the
DFR and the TLTRO rate). The main caveat is that the ECB will actually lose money on these operations.
However, this should not be a major source of concern, given that, as discussed in Chiacchio et al.
(2018), while it is preferable for the ECB to make profits rather than to record losses, it is not a profit-
maximising institution and its overriding mandate is price stability. As such, recording losses in the
short-to-medium term
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when seeking to fulfil its macroeconomic function, should not stop the ECB
from using such a policy if it is effective.
If the ECB believes it is approaching the reversal rate but it needs to provide more monetary easing, it
should therefore refrain from cutting its DFR again, and instead reduce further its TLTRO rate below
its DFR.
Next, how to deal with potential financial stability issues? As discussed before, negative rates for a
too-long period, which could be necessary to fulfil the ECB’s price stability mandate, could nonetheless
lead to financial instability in the medium- to long-run. In our view, the best way to deal with financial
imbalances is to use macroprudential tools as the first line of defence. However, the euro area’s
macroprudential institutional framework might not be able of playing this crucial role, given its
decentralised nature and heterogenous functioning across European countries. It is therefore critical
to build a better set-up for the use of macroprudential tools in Europe to ensure that they can be used
forcefully and in a timely way when needed.
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TLTROs I, which were the first refinancing operations conditional on new lending by the banks, were announced in June 2014. TLTROs II
were launched in March 2016.
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Assuming that the negative spread of 50 basis points between the deposit rate and the TLTRO rate would in the end apply to a volume
of between €500 billion and €1 trillion in loans, this would lead to losses on these operations of between €2.5 and 5 billion, compared
with an average of €14 billion of distributable profits per year for the Eurosystem from 1999 to 2017 (Chiacchio et al, 2018).