The rise in interest rates turns the ECB’s debt portfolio into a money-losing machine
The euro zone will soon have to pay for a decade of largesse from the European Central Bank. The rise in interest rates is turning the ECB’s bond portfolio acquired since 2014 into a money-losing machine. The question of how these losses are shared could become a major source of tension between Member States.
The amount of bank reserves created by the ECB with newly printed money now amounts to 3.9 trillion euros. The central bank pays its deposit rate, currently 2%, on those reserves. This supposes a transfer to European banks of about 78,000 million in 2023, or more if rates continue to rise. This exceeds the interest the ECB receives on its bonds, bought when rates were much lower.
Bond-buying losses will be particularly thorny in the euro zone. Critics of QE will see the losses as proof that the tool was risky. The National Bank of Belgium has warned that it could lose up to 9 billion in the next five years. If other central banks in the euro zone suffered similar losses in proportion to their stake in the ECB’s capital, the total could rise to 304 billion in that period. The central banks of the Member States are responsible for 80% of these losses, while the remaining 20% ​​corresponds to the ECB itself.
There are three ways to spread the damage. The first is to use the provisions accumulated by the national central banks in the last decade. These amount to about 300,000 million, according to the ECB. But central banks differed widely in their approach to provisioning, meaning some may be weaker than others. And they will resist exhausting their mattresses.
The second option would be for governments to intervene. A central bank cannot go bankrupt, but operating with low or negative own funds could damage its credibility. However, large taxpayer-financed recapitalizations, triggered by the need to pay banks, could create political problems. Countries with large banking systems, like France, or high debt, like Italy, might balk.
The third, more acceptable option would be to reduce the amount paid to banks, cutting interest on reserves. The ECB could pay its deposit facility interest rate for only some reserves, and a lower rate for the rest. However, some central bankers fear that this could compromise the transmission of monetary policy.
Banks will find themselves in the firing line when rates rise, even after suffering nearly a decade of underperformance from negative ECB rates. And even if central banks do not penalize them, they face the added risk that governments may tax them instead.
