ECB’s rate framework shift may affect money market lending

The European Central Bank (ECB) has introduced a new interest rate framework that could potentially discourage money-market lending, according to policymaker Joachim Nagel cited by Reuters on Thursday.

The framework, which was unveiled in March, sets a 15-basis-point spread between the interest rate that banks earn when they deposit money at the ECB and the rate they pay when they borrow.

The ECB’s goal is to gradually wean banks off free cash without causing disruption to the financial system after a decade of money printing.

However, Nagel suggests that the new framework might make it more cost-effective for banks to tap the ECB rather than lend in the money market.

Nagel, who is also the president of the Bundesbank, indicated that interbank transactions might require higher spreads. He warned that a spread of 15 basis points could risk pricing many transactions out of the market, which can still take place at a wider spread.

Nagel further added that banks are likely to turn to the ECB to swap illiquid collateral for reserves to meet some regulatory requirements.

The new framework is set for review no later than 2026, and Nagel hinted that changes might still be made. “Is that framework now set in stone? I don’t know yet,” he said. “But in the past, we have shown our capability and flexibility to adapt to changing market conditions.”

Nagel assured that his ECB colleagues would monitor money-market activity, fluctuations in short-term interest rates, and the degree of collateral transformation.