by Prof. Dr. Bernd Lucke and Prof. Dr. Dirk Meyer | October 31, 2024

A longer version of the article can be found at https://www.hsu-hh.de/ordnung/aufsaetze.

The central banks of the European System of Central Banks (ESCB) have created huge amounts of excess liquidity through the quantitative easing (QE) policy. This excess liquidity is held by the commercial banks in the Eurozone and is predominantly currently in the so-called deposit facility accounts of the national central banks.

There, the commercial banks of the Eurozone possess such large amounts of idle liquidity that practically no bank needs to borrow money from the ECB anymore. Therefore, the main refinancing rate has completely lost its guiding function as a key interest rate. Instead, the deposit rate now takes on a leading role as 'interest floor', because at a lower rate, no bank would be willing to lend its money. Conversely, this means that the ECB must pay banks a high deposit rate to prevent them from withdrawing their deposits and exchanging them for higher-yielding investments in the capital market. Because this would increase the money supply and massively decrease the capital market interest rate – in light of the targeted inflation goal, a monetary policy undesirable scenario.

Regarding the assets of the involved actors, QE essentially consisted of a swap transaction. The ESCB acquired fixed-rate bonds and, in return, created variable-yield assets (reserves) on the balance sheets of the commercial banks. This fixed-to-flexible rate swap burdens the ESCB exactly as long as it corresponds to the term or, in the case of premature sale, the holding duration of the securities acquired with a lower maturity yield of the ESCB. The expected present values would be equal in both cases.

As of September 2024, there are €3,016 billion parked in the ECB's deposit facility at an interest rate of 3.5 percent – risk-free and completely liquid. These enormous balances of the banks arose because the ECB, as part of QE, bought significant amounts of extraordinarily low-yielding government bonds from the banks. However, while the interest rates on government bonds are fixed until the end of their term, the ECB had to successively raise the interest rate on deposits from -0.5 to initially 4.0 percent since 2022 to counteract inflation. Despite the interest turnaround, which also led the deposit rate to currently fall to 3.5 percent, the Bundesbank and other central banks within the ESCB system have since incurred high losses, as the high interest payments to commercial banks are matched by only very low returns from government bonds. Thus, the average yield on the bonds held by the Deutsche Bundesbank (BBk) last year was just 0.37 percent, while the interest payments on the deposits of the commercial banks averaged 3.27 percent over the year. The negative interest margin of -2.90 percentage points resulted in a negative interest result for the BBk of minus €19.1 billion – the lion's share of the operational Bundesbank loss of a total of €21.6 billion reported for 2023. This corresponds to half a percent of the gross domestic product (GDP). The Austrian National Bank (OeNB) also recorded an annual deficit of €2.2 billion, which also represents approximately half a percent of GDP.

Losses of the central banks and idle interest income of the commercial banks

For the entire Eurosystem, our calculations show that the interest on deposits paid by the ESCB system in 2023 amounts to approximately €132 billion.[1] The OeNB paid out about €3.5 billion, and the BBK €41.1 billion. These interest incomes are received by the commercial banks without any recognizable consideration: The central bank deposits do not finance either investments or consumption, are completely liquid, and are safe as central bank money. This is a type of unconditional basic income that only benefits banks eligible for central bank liquidity.

As the ECB intends to continue managing its monetary policy in the future through the interest on large excess reserves, the commercial banks in the Eurozone will receive idle interest income of a similar magnitude for years to come. In contrast, the central banks of the solid euro countries must register significant losses, as their government bonds yield only extraordinarily low returns in their securities portfolios.

The interest income of the central bank from government bonds is central bank revenue. On the expenditure side, they are government expenses. From a government perspective – the state is the owner of its central bank – they are therefore irrelevant (left pocket – right pocket). In contrast, the interest income of commercial banks from central bank deposits in the deposit facility has negative earnings effects for both the central bank and the entire public sector. This creates a certain pressure on the ECB towards a fiscally oriented monetary policy with relatively low interest rates and, ceteris paribus, higher inflation.

The damage has been borne by government budgets in the form of reduced or completely defaulting dividend payments from their central banks. In Germany, it could even come to the point that the federal government must provide capital grants as a liability in its responsibility for the Bundesbank (Article 88 sentence 2 of the Basic Law), if its losses deplete its equity capital and, for example, for monetary policy reasons, it does not want to work with loss carryforwards. In any case, the revenue losses of the government budgets are borne by taxpayers.

The losses of the national central banks are matched by correspondingly high interest income of the commercial banks from their central bank holdings. While the amounts are generally not known for individual credit institutions, it is possible to estimate in specific cases from the annual reports what significance the interest on central bank deposits has on the earnings situation. Own calculations based on the consolidated balance sheet of Deutsche Bank 2022 show an increased reserve holding of about €100 billion compared to 2014, the start of QE. In the following year 2023, the bank estimated that with an average interest rate of the deposit facility of 3.4 percent, it earned around €3.4 billion from completely risk-free and absolutely liquid assets. This exceeds the average annual group profit of the last five years from 2018 to 2022 amounting to €2.78 billion. Therefore, only the earnings from deposits prevented a loss report.[2] Assuming a 'business as usual' scenario (remaining term of the government bond portfolio of the ESCB as of 31.12.2023 just over 7 years; no further securities purchases by the ECB; accompanied by a linear reduction of the current holdings (reserves) to zero over 15 years; average deposit rate of 3% over these 15 years), Deutsche Bank would achieve a present value of the interest income of €21 billion – without any risk. Similar estimates can likely be made for other banks.

Tax extraction – bank solidarity

From both a societal and economic perspective, we believe it is necessary to counter the unjustified subsidization of the banking sector. We therefore propose to extract the idle interest income of the commercial banks through monetary policy-neutral tax measures.

This should preferably be implemented as a profit-neutral taxation of commercial banks, to be decided as a simple legislative measure by the national legislator. Profit-neutral means that the tax burden is essentially increased by exactly the amount that flows to banks subject to tax in, for example, Germany and Austria, annually as unjustified, idle interest income from the ESCB system.

Naturally, this taxation must not interfere with the monetary policy of the ECB. Therefore, a direct taxation of interest income from the deposit holdings is ruled out. Otherwise, deposits would be dissolved and invested in other assets – with the undesirable effect of a declining capital market interest rate. Instead, a tax assessment base that does not provoke any avoidance reactions and therefore cannot have adverse effects on the monetary policy of the ECB is needed.

For this purpose, it makes sense to establish the idle interest income of each commercial bank based on their reserve holdings on a reference date in the past, e.g., December 31, 2022 (the year of the interest turnaround and the temporary halt of QE net purchases), as a permanently valid assessment basis. Since the QE stocks are to be systematically reduced and the deposit rate might also continue to decrease, the tax rate should be adjusted annually so that the tax revenue exactly corresponds to the interest payments made by the Eurosystem.

This does not preclude the possibility that commercial banks could actively use their reserve holdings to acquire other securities. While the actual reserve holding then deviates from the (historical) holding that serves as a basis for taxation, the expected present value of the acquired securities is the same as that of the excess reserves surrendered for them. Therefore, the bank always retains the equivalent of the current and future interest advantage. A tax that is levied based on fictitious interest income from excess reserves thus has precisely the desired effects until the complete reduction of the QE holdings.

It could rightly be called a Bank Solidarity Tax, as it demands the solidarity of banks with all other taxpayers who do not have the opportunity to generate idle income in the accounts of the central bank.

This kind of taxation does not contradict EU law. While it prohibits discriminatory relief, it does not prevent a taxation that can be justified. Since banks eligible for central bank liquidity are treated preferentially compared to all other citizens and businesses, which results in significant monetary benefits (windfall profits), the proposed increased taxation is well justified only for the privileged banks – and certainly much better than the current forbearance.

In the current situation, the question arises more whether the idle interest income does not represent a covert and unlawful state aid under EU law. Moreover, such aid was not decided by any parliament and thus lacks any democratic legitimacy.

Furthermore, it would certainly be desirable to coordinate such a tax extraction internationally (e.g., within the framework of the OECD) to prevent competitive disadvantages and tax-avoiding reactions. The chances for this seem to be good: Currently, idle interest income flows to the respective commercial banks in all OECD countries – to the detriment of national budgets and taxpayers.

[1] Calculation: Deposit funds 2023 (4,522 + 3,549)/2 x 3.27% p.a. = €131.96 billion. Due to the tiering system, smaller national deviations from the Bundesbank's information on the deposit rate must be assumed in the euro area.

[2] See in detail Lucke and Meyer (2024), p. 254 ff.

References

Essays and Monographs

▪  Arnold, Martin (2023), Bundesbank looks to aid savers by cutting lenders’ interest payments, Financial Times, 17.11.2023, https://www.ft.com/content/613dc842-1b53-49e5-921a-d1eb5e46931f (Accessed 20.02.2024).

▪  Deutsche Bundesbank (2023), Monthly Report, March 2023, 75th Year (2023), No. 3, Frankfurt a.M.

▪  Deutsche Bundesbank (2024a), The annual financial statement of the Deutsche Bundesbank for the year 2023, Business Report 2023, published on 23.2.2024, https://publikationen.bundesbank.de/publikationen-de/berichte-studien/ geschaeftsberichte/geschaeftsbericht-2023-923828?article=der-jahresabschluss-der-deutschen-bundesbank-fuer-das- jahr-2023-924248#Tab11 (Accessed 28.02.2024).

▪  Deutsche Bundesbank (2024b), Monthly Report, March 2024, 76th Year (2024), No. 3, Frankfurt a.M. ▪  Lucke, Bernd (2023), Unconditional Basic Income for Banks, in: Cicero, 10.12.2023, https://www.cicero.de/ wirtschaft/europaische-zentralbank-bedingungsloses-grundeinkommen-fur-banken (Accessed 11.04.2024).

▪  Lucke, Bernd (2024), Central Bank Losses and the Shareholder Values of Commercial Credit Institutions, Working Paper, University of Hamburg, https://www.wiso.uni-hamburg.de/fachbereich-vwl/professuren/lucke/bilder/lucke-central- bank-losses-and-the-shareholder-values-of-commercial-credit-institutions.pdf (Accessed 18.02.2024).

▪  Lucke, Bernd and Meyer, Dirk (2024), Central Bank Losses and Idle Interest Income for Commercial Banks – A Proposal for Extraction, in: Journal for Banking Law and Banking Economics, Vol. 36 (2024), No. 4, pp. 252-260..

▪  Market Screener (2024), Hapag-Lloyd AG, https://de.marketscreener.com/kurs/aktie/HAPAG-LLOYD-AG-24857717/ fundamentals/ (Accessed 08.04.2024).

▪ Oesterreichische Nationalbank (2024), Business Report 2023, https://www.oenb.at/dam/jcr:14ecd93e-4e54-4975-b784- cc9c3c80e7f3/GB_2023.pdf (Accessed 12.07.2024).

▪  Preuß, Susanne (2022), Who has the license to print money, in: Frankfurter Allgemeine Zeitung, Frankfurt, 22.02.2022 p. 22.

▪  Wettach, Silke (2023), “This will lead to an outcry”: ECB Council member Holzmann demands higher minimum reserve, in: WirtschaftsWoche, Düsseldorf, 27.09.2023, https://www.wiwo.de/politik/europa/mindestreserve-der-geschaeftsbanken-das-wird-jetzt-zu-einem-aufschrei-fuehren-ezb-ratsmitglied-holzmann-fordert-hoehere- mindestreserve/29414688.html (Accessed 13.02.2024).

Legal Regulations and Data

▪  European Central Bank, ECB Data Portal, https://data.ecb.europa.eu/search-results?searchTerm= (Accessed 20.06.2024).

▪  EU Treaty, Version based on the Treaty of Lisbon that entered into force on December 1, 2009, Consolidated version published in OJ C 115 of 9.5.2008, p. 13, last amended by the Act on the conditions for the accession of the Republic of Croatia and the adjustments of the Treaty on European Union, the Treaty on the Functioning of the European Union and the Treaty establishing the European Atomic Energy Community (OJ EU L 112/21 of 24.4.2012) effective from 1.7.2013.

▪  Law for the introduction of an EU energy crisis contribution according to Regulation (EU) 2022/1854 of December 16, 2022 (BGBl. I p. 2294, 2325). ▪  Basic Law for the Federal Republic of Germany in the amended version published in the Federal Law Gazette Part III, structure number 100-1, which was last amended by Article 1 of the Law of December 19, 2022 (BGBl. I p. 2478) – GG.