European banking has found unexpected manna in the ECB’s interest rate hikes. Beyond the obvious benefit that this increase represents for the business margin, with more expensive credits, the sector is benefiting from the interest with which the central bank is remunerating the excess liquidity of the sector. It pays 0.75% for the deposits parked in the ECB piggy bank, a remuneration that will continue to rise and therefore generate greater profits, in a dynamic that Christine Lagarde plans to put a stop to. CaixaBank is the Spanish bank that benefits the most from this and has the most to lose from possible changes, according to Goldman Sachs.
The bank obtained ultra-cheap financing from the ECB during the pandemic, even receiving money for requesting it, through the so-called TLTRO III lines, aimed at keeping the granting of credit alive. European entities still have to return 2.1 trillion euros of that liquidity granted over a period of three years and they find it much more attractive to transfer that excess liquidity to the ECB’s piggy bank than to return it in advance. Thus, the current rate of the deposit facility, 0.75%, is higher than that of the TLTRO financing lines.
Analysts expect the ECB to announce measures to reduce the attractiveness of these TLTRO lines, now under very favorable conditions since the interest paid by financial institutions is set at the average rate of the deposit facility throughout the life of the operation. , below the current 0.75%. As Pictet points out, these windfall profits “occur at a time of shock history of income currently suffered by households due to inflation. So there is political pressure.” In fact, in countries like Spain, a tax on bank profits has been announced.
In Goldman Sachs they point out that the arbitration that the bank is now carrying out, by parking the surplus liquidity of the TLTRO in the deposit facility, has a clear positive effect in annualized terms for the banks of the euro zone that it covers. In general terms, it represents an increase over its forecasts for 2023 of 5% in the interest margin, 10% in profit before taxes and 89 basis points in profitability (ROTE). Italian and French entities are the most benefited.
CaixaBank is by far the Spanish bank that takes the most advantage of the situation and has the most to lose with the changes that the ECB may introduce. Under current conditions, and if the ECB continued to remunerate all excess liquidity with the deposit rate, CaixaBank’s gross profit would rise 16% compared to Goldman Sachs’ estimate for 2023; its interest margin, 5% and its ROTE, at 89 basic points. Only Credit Agricole, ABN Amro and Unicredit record a higher positive impact.
Santander and BBVA, on the other hand, appear among the least benefited and therefore less exposed to tightening by the ECB on excess liquidity. If there were no changes, Santander’s estimated gross profit increase would be 5%, with a 2% rise in interest margin. And for BBVA, a 4% rise in profit before taxes and a 2% rise in interest margin.
If we don’t put a stop to these heaven-sent benefits, the positive effect would be much greater with the rate hikes that are expected, unsustainable in the face of public opinion given the rising cost of living and financing, which is driving the euro zone into recession. If the ECB left things as they are on excess liquidity and the deposit rate rises to 2.75% in mid-June 2023, the gross profit increase over the US bank’s initial estimates would skyrocket to 29% on average. in European banking, according to Goldman Sachs forecasts. And the increases in gross profit estimated by Goldman Sachs would be 45% at Caixabank or 53% at Credit Agricole.
Goldman Sachs argues that the most effective and least disruptive way to end these windfalls would be to change the terms of the TLTRO, albeit retroactively, to bring its cost in line with that of the deposit facility. “Although this option supposes the total loss of the potential arbitrage benefit for banks, we believe that the consensus still does not capture the potential arbitrage benefits, so it should not lead to downgrades in the estimates,” explains the bank. And he adds that with less favorable conditions to keep money in the ECB, banks could reinvest their excess reserves in sovereign bonds or in the money market to compensate for this loss of profitability.
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