When the Swiss central bank announced change to its renumeration of excess reserves held by commercial banks, I voiced skepticism that this would work. Specifically, I wrote that “when the system has large amount of excess reserves then this renumeration scheme should negate the increase in policy rates” and later that “one could address this by increasing the threshold [b]ut this would negate the desired goal of this policy which is decreasing the sums paid to commercial banks”. Few months later, we know that the Swiss central bank did exactly what I said in the second part of the quote: it set the threshold above which excess reserves earn 0% interest to very high number – 28 times the required reserves. So while marginal excess reserves do pay 0% interest rate, the point where this marginal rate starts to apply is very high, so high that most (or no?) banks actually reach it.
In terms of the overnight market this means that there are banks
that will borrow excess reserves at rates close but below the deposit rate,
since they will be able to earn the deposit rate. In aggregate, the overnight (SARON)
rate will stay close to the deposit rate, something we have indeed observed
since the change (see picture below). The only difference is that the overnight
rate is slightly below the deposit rate, rather than slightly above deposit
rate, as was the case before the change. This reflects the fact that the banks
lending reserves out now earn rate below deposit rate (0%), while borrowers earn
deposit rate, so that the price of the transaction has to be in between those
two. (Before lenders earned deposit rate, so the lower bound was the deposit
rate; borrowers presumably would have to borrow at equivalent of marginal refinancing
rate).
What about the effect on the payments from central bank to
the commercial banks, which is presumably the main motivation? Of course, the
policy means that for the 28-multiples of required reserves it is the deposit
rate that applies, which means that the central bank is still paying large sums
of money to commercial banks, despite the change it did. So, this policy should
achieve very little in the direction of the desired outcome of lowering payments
to commercial banks and corresponding losses for the central bank. That said, it
does not achieve zero effect: as long as some banks are above the 28-multiple
threshold, which is presumably the case, they are being paid less than what they
would be paid otherwise.
So why did the Swiss central bank do it? It is hard to say.
Partly, it might be simple theater for the public: setting the marginal rate
for excess reserves to 0% means that the central bank can claim it did something.
Equally, it might be issue of redistribution of excess reserves and profits: the
change pushes excess reserves towards banks that are below the threshold and punishes
banks with largest amount of excess reserves. What else? I think the evolution
of ESTR, which stayed close to deposit rate despite it rising above 0%, makes
it clear that the change can hardly be motivated by desire to impact the market
interest rates, as the bank claimed; if anything, the move leads to slightly lower
market interest rates.[1]
What does all this imply for the future behavior of the ECB?
The fact that this is a lot about playing politics, rather than macroeconomic or
financial policy, it is hard to know what the ECB will do. There are arguments
for it not to do anything. First, it would avoid the whole messy business, including
possible unintended consequences, perspective that might win given the limited
effect on what it is supposed to achieve. Second, since it leads to lower overnight
rate, and the magnitude of the effect might be hard to calibrate – especially in
euro zone money market with much larger number of commercial banks and much
bigger heterogeneity of excess reserves (see below).
That said, the ECB might still go for it despite the limitations.
Apart from doing something for the sake of doing anything, even if the savings
for the central bank would be small, the main motivation I could see is the
positive effect on the redistribution of excess reserves: with potentially large
costs of missed opportunity for banks above the threshold, there would be
strong incentive for them to lend their reserves to banks below threshold. In environment
of much higher overall interest rates this could have desirable financial stability
effects. That said, since German banks would be hurt the most in terms of lost
profits, the redistribution effects could also be a reason why this does not
pass – the German central banker might not be too happy about this.
On balance, I now think that the ECB will stay clear of any
change. It feels like that if they would do anything, they would have done it
already when the changed the LTRO terms. The fact that back then they went for
lowering the interest rate on required reserves – from main refinancing rate to
deposit rate – but not for tiering suggests that they might have decided that
going down this road offers too little benefit and too much risk. But of
course, the ECB could easily surprise me once again.
[1] Specifically,
the bank said that it “ensures that the secured short-term Swiss franc money
market rates remain close to the SNB policy rate”. True, they mention secured
rates, which in euro zone are disconnected from the deposit rate, but that is
mostly down to collateral shortage, and I don’t see how renumeration change
affects that.
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