Winners and losers from the ECB’s negative interest rate policy

Seven years ago, the European Central Bank pushed policy rates into negative territory. It has led to substantial redistributive effects within the eurozone banking sector

Seventh anniversary of negative rates…

It is already seven years ago, June 2014, that the European Central Bank (ECB) first imposed a negative rate on the reserves that banks hold at the ECB. The ECB started cautiously, by charging ‑10bp on reserves; the latest increase to ‑50bp dates back to September 2019. Targeted Longer-Term Refinancing Operations (TLTROs) were also announced in June 2014. Initial TLTRO operations came with a “traditional” positive interest rate: banks paid interest on their TLTRO borrowing from the ECB. Starting with TLTRO-II in 2016, the ECB added an incentive for banks to extend business and non-mortgage household credit, by making the TLTRO-rate dependent on bank lending performance. Banks could obtain negative rates up to the deposit rate (then -40bp), depending on their lending performance.

Reserves and TLTROs are distributed unevenly across the Eurozone

It is important to note that bank reserves and bank funding requirements were, and are, not distributed evenly across the eurozone. This has to do with different domestic characteristics of banking sectors and broader financial markets, and international investor preferences.

Since the onset of the pandemic, TLTRO funding has become attractive even for banks that are awash in funding and excess reserves

Generally speaking, banks in northern eurozone countries tend to hold relatively more excess reserves, while banks in southern countries have less of those, and in turn have been more keen to borrow funds from the ECB. Since the onset of the pandemic in 2020, the ECB has relaxed TLTRO lending benchmarks and rate rewards to such an extent that TLTRO funding has become attractive even for banks that are awash in funding and excess reserves. This has led to a strong take-up of TLTRO-III loans by northern banks as well since mid-2020.

Costs and gains of negative rates illustrate redistributive effects of monetary policy

Due to the uneven distribution of reserves and TLTRO borrowing across the eurozone, the costs and gains of negative rates are very different across countries. The chart below shows the ratio of funds borrowed from the ECB (mainly TLTRO, but also including other refinancing operations) over bank reserves deposited at the ECB, per country. We take August 2019, preceding the announcement of TLTRO-III and tiered reserve remuneration in September 2019. The Greek and Italian banking sectors at that time had borrowed more than three times the amount from the ECB than they had deposited. Ratios in Spain and Portugal were well above 1. The German, French and Dutch banking sectors, on the other hand, had ratios well below 0.5, meaning their ECB borrowing was less than half (in the case of Germany and the Netherlands less than a fifth) of the reserves they had deposited with the ECB.

Ratio of refinancing operations over reserves, Aug ’19

Macrobond, ING
Macrobond, ING

This country-level data on TLTROs and excess reserves also allows us to attach a price tag to the observed differences. We hasten to add that this should not be seen as a country-by-country cost-benefit analysis of the full set of ECB monetary policies. Those policies have been, and continue to be, aimed at eurozone-wide inflation and economic growth. And indeed all eurozone individuals and companies have benefited. By avoiding deflation and keeping rates low for an extended period of time, the ECB has fostered economic growth and financial stability.

Pursuing monetary policy goals comes at the cost of redistributive effects, in this particular case across banks

These positive effects of broad monetary policy are not what we want to call into question here. Instead, by zooming in on the negative rate revenues and expenses associated with reserve holdings and TLTROs, we can calculate the narrow gains and losses of negative rate policies for banks. This illustrates that pursuing monetary policy goals comes at the cost of redistributive effects, in this particular case across banks.

Reserves: more excess in the North

Banks have limited control over the quantity of reserves they deposit at the ECB, as we have explained elsewhere (in short: roughly half of the reserves the eurozone banking sector collectively holds, are a direct consequence of ECB asset purchases, and thus beyond banks’ control). From 2014 until October 2019, the negative rate imposed on reserve holdings was quite straightforward: it was calculated over excess reserves – reserves over and above what regulation requires banks to hold given their deposit liabilities issued. In October 2019, the ECB reduced the negative rate burden by introducing “tiering”. It started to calculate a negative rate exemption of (then and currently) six times required reserves meaning that, in total, seven times required reserves are exempted from negative rates. The -50bp deposit rate is imposed on the remaining “non-exempted excess reserves”. The chart below breaks up reserve holdings in required, exempted and non-exempted per country. It shows the situation in December 2019, the first “reserve maintenance period” to which tiering was applied. It’s clear from the chart that at that time, negative rates were still charged on a big chunk of reserves in countries like Germany, France and the Netherlands (red bars), while the part of reserves exempted from negative rates was much bigger in relative terms for e.g. Spain and Italy (blue bars). It should be noted that the situation changed markedly in 2020, when bank reserves swelled in all countries, boosted by resumed ECB asset purchases and increased TLTRO borrowing. As a result, non-exempted reserves (red bars) have now become the biggest part of reserves in all countries.

Eurozone bank reserves at Eurosystem and sums borrowed under LTROs, year-end 2019

Macrobond, ING
Macrobond, ING

TLTRO borrowing: more popular in the South (until 2020)

As noted earlier, the TLTRO rate has been tied to bank lending performance since 2016. Until the pandemic struck last year, the best obtainable TLTRO rate was equal to the deposit rate. Banks could (partly) offset the negative rate costs on their reserves with the negative rate revenues on TLTRO borrowing. Insofar as TLTRO borrowing exceeded (non-exempted) excess reserves, banks could even make a profit. TLTRO borrowing exceeded reserves in Spain, Italy, Portugal and Greece in the years 2016-2019.

TLTRO borrowing exceeded reserves in Spain, Italy, Portugal and Greece in the years 2016-2019

Indeed during that period, TLTRO negative rate revenues exceeded negative rate expenses on reserves for the Italian banking sector, resulting in what we call a positive narrow gain from negative rates averaging €730m/year (see chart below). For the Spanish banking sector, this was about €430m/year. The German banking sector, in contrast, booked a narrow negative rate loss of €1.1bn/year, Dutch banks around €620m/year and French banks around €360m/year.

When the pandemic struck in March last year, the ECB changed the terms of the ongoing TLTRO-III, relaxing the lending benchmark and lowering the best obtainable TLTRO rate to -100bp. This allowed banks to not only offset reserve rate costs by TLTRO rate revenues, but to actually make a positive carry – provided they met their lending benchmarks, of course. Unsurprisingly, the strong new incentive attached led to the TLTRO borrowing surge the ECB had in mind, to make sure that a lack of liquidity would not be a problem in the financial system. As a result, since June 2020, the net monthly narrow result of negative rates (TLTRO rate revenues minus reserve rate costs) has turned positive for Germany, France and the Netherlands, and has increased markedly for Italy and Spain

Annual negative rate revenues and costs for banks per country (€ tr)

Macrobond, ING
Macrobond, ING

The bill, please! The cumulative result of negative rate policies

The cumulative narrow result of negative rate policies differs markedly between countries, up to €10bn between Germany and Italy

Although the monthly narrow result of negative rate ECB policies has turned positive in most countries now, the cumulative result since 2016 still differs markedly between countries, up to €10bn between Germany and Italy. The chart below shows that Italy and Spain had the highest net revenues (€5.9bn and €3.5bn per April 2021, respectively); banks in those countries both took out TLTRO loans early and had relatively low excess reserves. Banks in Germany and the Netherlands have faced the biggest net costs, as they had relatively high excess reserves and borrowed few TLTRO funds until mid-2020. The current (April 2021) net interest result is ‑€4.0bn for Germany and ‑€1.9bn for the Netherlands. France is in between these two groups (-€0.2bn), having both relatively high excess reserves but also higher TLTRO borrowing.

Eurozone banks, cumulative ECB negative rate flows since June 2016 (€ billion)

Macrobond, ING
Macrobond, ING

As emphasised earlier, this overview of narrow revenues and costs of rates on TLTROs and excess reserves should not be interpreted as an encompassing assessment of gains and losses of monetary policy. That said, it does show that unconventional monetary policy, like most policies, has redistributive consequences, also within the banking sector.

This article originally appeared on

Why banks need to pay attention to where a digital euro is heading

The European Central Bank makes clear that the development of its “digital euro” will take several years. Yet given the geopolitical context and the potential impact, banks should better pay attention

This week, the ECB published an overview of the consultation responses it received on its digital euro survey.

The results show a variety of demands a digital euro would need to fulfil, including privacy, security, low costs and ease of use. Before discussing the ECB’s next steps, it’s worth recapping how we got here.

From tech gimmick to must-have in a few years

Central bank digital currencies (CBDC) discussions were mostly academic when bitcoin appeared on stage.

Back then, technical aspects of blockchain and monetary aspects of running a currency in a decentralised context drove interest. Central banks were comfortable discussing pros and cons in a non-committal way, and experimenting a bit, as it all remained a rather abstract discussion. A few central banks went further exploring specific use cases, such as the Swedish Riksbank facing declining use of physical cash.

The prospect of a private stablecoin pushing central banks into irrelevance turned into a real possibility

This all changed profoundly when Facebook launched its ideas for a global stablecoin (Libra, now called Diem) back in 2019. All of a sudden, the prospect of a private stablecoin crowding out fiat currencies and pushing central banks into irrelevance turned into a real possibility, given Facebook’s vast global user base.

The response was two-pronged: on the one hand, strong pushback against Libra/Diem, which subsequently watered down its plans considerably. On the other hand, central banks such as the ECB started to look into CBDC more seriously. Around the same time, it became clear that China had been quietly working on its own CBDC (called DC/EP) at least since 2014. DC/EP pilot projects were launched in 2020, and there are persistent rumours about a broader rollout, perhaps in 2022.

Digital currency as tool in global power play

For Europe, it is important to understand the geopolitical context in which the ECB is considering the digital euro. There is a widely shared concern among policymakers about Europe’s dependence on foreign big tech platforms and Europe’s “strategic autonomy”. There is a lot to be said about both, but the euro and digital payments have been identified as an important factor reducing foreign dependence and strengthening Europe’s role in the world. 

China and Europe share a wish to become less dependent on the dollar for international payments. 

China and Europe share a wish to become less dependent on the dollar for international payments. As for the former, the DC/EP might be an instrument to achieve this, though its focus is mostly domestic. Next to DC/EP, China has been developing its Cross-border Interbank Payment System (CIPS) to facilitate renminbi payments since 2015. The PBoC joined the Multiple CBDC (mCBDC) Bridge project, which explores multi-currency cross-border payments on a Distributed Ledger Technology (DLT) infrastructure.

Different goals, different solutions

In this context, and faced with these developments, it makes sense for the ECB to explore its options for a digital euro. Simultaneously, a multitude of goals is a problem for the digital euro project because different goals may require very different, and even conflicting, design choices.

Different goals may require very different, and even conflicting, designs

Building a digital euro to bolster the international role of the euro requires an infrastructure that is accessible by foreign institutions that can settle large-value payments and allows easy exchange with foreign currencies. Applying the appropriate lingo requires a multi-currency wholesale CBDC solution. But building a digital euro for small domestic retail payments, on the other hand, may require an infrastructure that is interoperable with existing point-of-sale terminals and a variety of digital platforms, works offline too, and has guaranteed user privacy while preserving transaction monitoring to avoid money laundering and terrorist financing.

An overarching condition for any CBDC solution is that it does not destabilise the financial system by draining commercial bank deposits in unpredictable ways.

Where we’re heading

It is far from certain that a single digital euro solution can satisfy all of these different requirements. Rather, different solutions may need to be considered for the different goals. Projects by other central banks and private parties typically distinguish domestic retail oriented use cases (like the Riksbank’s e-krona) from cross-border, large value and cross-currency ones (like mCBDC and its predecessor project). It is not entirely clear yet which direction the digital euro will take, although it appears to move more in the retail direction. That said, we expect the ECB to keep an eye on the geopolitical context as well, which means the wholesale cross-border direction is not out of scope yet.

Another important distinction to make is that between the payment method and the underlying currency. The digital euro as a currency could be incorporated into existing payment methods. If payment schemes can incorporate bitcoin in their offering, adding a digital euro will surely not be a problem. If the ECB wants to offer the digital euro as a solution where payments data are never processed by private sector players, as Panetta suggested, then launching it as a currency only is not enough. The ECB may also have to develop its own payment method as well — or at the very least, it will have to regulate payment processing by private parties strictly. 

Why banks should pay attention to the ECB’s next steps

In a European Parliament hearing, ECB Board Member Fabio Panetta has indicated that a formal decision will be made over the next few months to start a formal investigation phase. Taking about two years, this phase would “carefully analyse possible design options and user requirements”. Only on the conclusion of this phase, so in 2023, the ECB would decide on the design. The next phase, taking “several years”, would include actual testing and live experimentation. And only after that, the ECB would take a go/no go-decision. The ECB has indicated that this will not be before 2025.

A digital euro might have a strong impact on the structural availability and cyclical volatility of deposit funding

While this looks far off, banks should continue to pay attention. A digital euro might have a strong impact on the structural availability and cyclical volatility of deposit funding. We do not expect the ECB to allow a digital euro to blow a hole in commercial banks’ balance sheets, but the discussion about what is needed to avoid this is still ongoing. Moreover, a digital euro would pose new challenges to the relationship banks want to maintain with their clients, on top of the already intensifying competition by fintech and big techs.

Non-bank service providers might also offer a digital euro wallet. In combination with adjacent policy developments such as payments data sharing under the Payment Services Directive 2 and forthcoming Open Finance, as well as the increasing popularity of cryptocurrency and growth of “decentralised finance”,  banks may increasingly have to ask themselves how they may serve their customers’ future needs, and how they can distinguish themselves from their bank and non-bank competitors in doing so.

 This article first appeared on ING THINK 

ECB reserve tiering: time for recalibration?

The European Central Bank introduced “tiered” remuneration for bank reserves in October 2019. Since then, bank reserves at the ECB have doubled, but the tiering methodology has remained unchanged. There may be reason to revisit it

Tiered remuneration on reserves: how does it work?

Bank reserves at the ECB have been subject to negative rates since June 2014. In late 2019, the ECB decided to exempt some bank reserves from this negative rate. The “exemption allowance” was set at six times required reserves (plus required reserves themselves, making seven times required reserves in total). Required reserves, in turn, are a percentage of deposits and other short-term liabilities that banks have issued to the general public. So loosely speaking, if households or businesses deposit an amount of money at a bank, then the exemption allowance for that particular bank increases by 7% of that amount (seven times the required reserve ratio of 1%), allowing it to have more reserves at the ECB without facing the negative deposit rate. If banks extend credit to the real economy, this will also create more deposit liabilities for banks, which in turn increases the amount of reserves that banks can park at the ECB without paying negative rates.

The exemption allowance share of reserves has almost halved

The share of bank reserves exempt from negative rates has dropped from 50% in late 2019 to 28% today

When the exemption allowance was first enacted, about half of all bank reserves at the ECB qualified. Yet as the pandemic struck Europe, the ECB conducted new TLTRO operations, restarted its Asset Purchase Programme (APP) and implemented an additional Pandemic Emergency Purchase Programme (PEPP). Together, these programmes caused bank reserves at the ECB to double in a year’s time to over €3700bn today. The exemption allowance increased as well, in tandem with bank liabilities. But the allowance increase came nowhere near the increase in total reserves, and as a result the exemption allowance share has dropped from 50% in late 2019 to 28% today (see chart below). The negative rate costs that banks incur over their reserves has correspondingly increased. Has the time come for the ECB to review its exemption parameters?

Bank reserves at Eurosystem and exemption allowance share


For “involuntarily” held reserves only!

One could ask, why would the ECB give a free gift to banks in the form of negative rate exemptions? An answer to this justified question could be: indeed the ECB should only provide relief for reserves that banks cannot avoid holding. It should not be so generous with reserves that banks voluntarily choose to hold. The latter applies e.g. to reserves that are created as a consequence of TLTRO-borrowing by banks. The costs and benefits of those reserves should be assessed in conjunction with the TLTRO borrowing rates the ECB applies.

It seems neither necessary not warranted to exempt reserves that are a consequence of TLTRO loans

If banks don’t like paying the negative rate costs on these reserves, they should repay their corresponding TLTRO loan. The fact that many banks choose to keep their TLTRO loans, shows that the benefits exceed the negative rate cost of holding the corresponding reserves. It therefore seems neither necessary not warranted to exempt reserves that are a consequence of TLTRO loans.

But how about reserves that banks cannot avoid? Asset purchases (APP and PEPP) are an ECB initiative. While it could be argued that banks indirectly benefit as asset purchases contribute to a healthier economy and compress credit premiums, in a direct sense they lead to higher bank reserves and associated negative rate costs. Isn’t this like the government obliging people to hoard toilet paper, and then proceeding to tax toilet paper holdings? The box below explains in more detail why asset purchases necessarily lead to higher reserves that banks collectively cannot avoid, and how this differs from the reserves over which banks do have influence.

 Monetary operations since 1999: the ECB’s Money Trumpet

To explain today’s glut of excess reserves, it helps to briefly review the history of the ECB’s monetary policy operations. In an effort to present geeky monetary stuff as something cool, we’ll refer to it as the ECB’s Money Trumpet. The chart below shows supply and uses of liquidity in the base money market – the market where central and commercial banks interact – from the perspective of the Eurosystem’s balance sheet. We won’t attempt to summarise the ECB’s monetary operations in just a few paragraphs, but the Money Trumpet shows five phases of ECB liquidity policies in action. Key to understanding this chart is the law of double-entry bookkeeping dictating that any asset acquired by the Eurosystem (liquidity supplied to the market, recorded above the x-axis) is matched 1-on-1 by a Eurosystem liability increase (liquidity parked at the Eurosystem, recorded below the x-axis).

ECB Money Trumpet: Eurosystem liquidity supply and absorption (€ tr)


1. 1999-2008: the good old days

The first phase runs from 1999 until 2008. During this time, Eurosystem liquidity was steady and predictable. The Eurosystem made sure liquidity was always tight, meaning there was net demand for liquidity from banks. By offering liquidity sources in scarce quantities, the ECB could steer money market rates. The auctions of ECB liquidity supply (the open market operations) were capped, meaning that banks were oftentimes only allotted part of what they had asked for. The flipside of this was that bank reserves at the ECB were low as well. Aside from the required minimum reserves, “excess” reserves tended to be minimal.

2. 2008: switching to full allotment

As the interbank market dried up in 2008, maintaining tight liquidity in the system became too risky. The ECB instead switched to full allotment auctions, allocating banks whatever credit they asked for. Indeed Eurosystem claims on banks under open market operations increased. Bank reserves at the ECB increased in tandem. The abundance of excess reserves meant that at least the financial system would not be brought down by liquidity shortages, even as interbank lending had all but stopped.

3. 2015: fighting the deflation demon

The policy goal of achieving flush liquidity with full allotment auctions remains in place today. But in 2015, the ECB added another element. It embarked on large-scale asset purchases (in fact asset purchases had started in 2009 already, but on a limited basis only). Indeed, bank reserves at the ECB increased in step with asset purchases. Excess reserves in the system ballooned.

It is here that our distinction becomes clear between reserves that banks hold by choice, versus reserves they cannot avoid. The ECB’s auctions (open market operations) had always resulted in liquidity supplied at the request of banks. The resulting bank reserves were thus driven by bank demand. The newly introduced asset purchases however are “supply-driven”. They are initiated and controlled by the Eurosystem. They too result in bank reserve increases, but not at the request of the banks, nor do the banks have a choice here. They can merely try to push the hot potato around between them, but they cannot influence the total amount of reserves created by ECB asset purchases.

4. 2019: introduction of tiered remuneration on deposits

The ECB decelerated and then stopped its large-scale asset purchases in 2018. As the ECB continued to reinvest maturing assets, excess liquidity in the form of bank reserves at the ECB stabilised, but did not drop. In September 2019, the ECB introduced a two-tier remuneration system for excess liquidity, to “support bank-based transmission of monetary policy”. The first tier, the allowance of currently six-plus-one times required reserves, is exempt from the negative deposit rate. The light orange part in the chart below shows the estimated exemption allowance. Note that in practice, exemptions are calculated per individual bank, and may therefore be lower for some banks (if their excess liquidity remains below their allowance). Therefore, the shown aggregate allowance should be interpreted as an upper bound estimate.

Bank reserves at Eurosystem, attributed to liquidity sources (€ trn)


5. 2020: Renewed asset purchases and TLTROs

In April 2020, the pandemic prompted renewed asset purchases plus an expansion of long-term refinancing operations. Bank reserves increased from €2046bn on 31 March to €3740bn today and with further asset purchases and TLTRO operations in the pipeline, the end is not in sight.

 Thanks, but how do ECB asset purchases drive higher reserves?

When the ECB (strictly speaking, the Eurosystem) buys a government bond or any other asset directly from a bank, it credits the bank’s reserve account. As such, the ECB’s balance sheet lengthens: it acquires an asset (the bond) and a liability (increased reserves). When the ECB buys a bond from e.g. a pension fund, more steps are involved, but the effect on reserves is the same. As the ECB acquires the asset, it credits the reserves of the bank where the pension fund has an account. The ECB instructs the bank, in turn, to credit the pension fund’s bank account. The pension fund may move the deposit to another bank or reinvest in another asset, but this does not reduce the reserves in the system. The reserves created by the asset purchase are an ECB liability, and can only be reduced at the ECB’s discretion, if it decides to sell the bond again (or to not reinvest the principal when the bond matures). Of course, individual banks can try and reduce their reserves, but total reserves in the system (insofar as they are created by ECB asset purchases) are determined by the ECB.

Without further measures, the negative rate calculated over involuntarily held reserves could almost double this year 

Armed with this knowledge about the role of monetary operations and asset purchases, we can now split bank reserves into a voluntary and involuntary part. We do this by allocating reserves to these two sources of liquidity. This allocation cannot be calculated to the last euro, therefore we provide a range estimate based on different liquidity attribution assumptions. The exempted allowance amounted to roughly 70% of “involuntary” bank reserves in late 2019. As the ECB restarted its asset purchase programmes in 2020, the share of the exempted allowance in “involuntary” reserves started to fall, reaching about 50% currently and set to fall further in the year ahead. Without further measures, the negative rate calculated over involuntarily held reserves could almost double this year, from about €2.5bn in 2020 to some €5bn in 2021. 

Bank reserves at Eurosystem, attributed to liquidity sources (€ bn)


But isn’t the TLTRO negative rate borrowing compensating for all of this?

So, you may say, this complicated reasoning about where reserves come from is all very well, but if banks meet their TLTRO benchmark lending, then the negative rate they pay on their reserves is in fact more than compensated for by the negative rate they get paid on their TLTRO borrowing – at least in 2020 (see table). So why worry about negative rates on reserves?

Indeed over the past year and TLTRO iterations, the ECB has progressively lowered the TLTRO borrowing rate further into negative territory. The most recent TLTRO-III offers a base borrowing rate equalling the deposit rate (-50bp). This means that the negative borrowing rate banks receive on their TLTRO borrowing, and the rate they pay on the corresponding “voluntary” reserves, cancel out. In other words, the negative rate costs for banks associated with the “voluntary” reserves are matched by TLTRO borrowing rate revenues. This leaves the involuntary reserves.

The TLTRO “bonus” rate is not meant to address negative rate costs of reserves. It serves the separate goal of incentivising bank lending to the real economy

Yet with TLTRO-III, the borrowing rate drops to -100bp if banks succeed in attaining a certain benchmark lending to the real economy. As can be seen from the table above, this “bonus” rate revenue (€4.3bn) exceeded APP+PEPP rate costs in 2020 (€2.2-3.1bn), provided benchmarks have been reached, which is likely the case for most banks, though not all.

Yet this TLTRO “bonus” rate is not meant to address negative rate costs of reserves. Instead, it serves a separate policy goal, namely “incentivising bank lending to the real economy”. In our view, one instrument (the TLTRO rate in this case) can serve only one policy purpose at a time. This goal should not be conflated with the issue of involuntary reserve costs.

Besides, there are composition effects to take into account: the banks that take out TLTRO loans and those that hold the highest reserves, are not necessarily the same. Moreover, whether banks will reach their benchmark lending in 2021 too, remains to be seen. Business credit demand has been weak in recent months, and the outlook isn’t great either. Given all these considerations, a review of tiering might increasingly be warranted as asset purchases continue to add to reserves. Whether the ECB sees it this way too, is a different matter.


Initially, tiering was calibrated in such a way that some 71% of reserves that banks hold involuntarily as a result of ECB asset purchases, was exempt from negative rates. At the time of writing, this share has dropped to just above 50%. With the ECB having committed to further asset purchases, involuntary reserves may increase by a few hundred billion more this year. As the negative rate-exempted allowance is linked to bank liabilities, it rises much more slowly, and thus shrinks as a share of involuntary reserves. Negative rate costs of involuntary reserves may double in 2021 compared to 2020. The question thus becomes increasingly pressing as to whether the ECB will revisit the tiering methodology. This will depend on whether the ECB considers the TLTRO arrangement exclusively to incentivise lending to the real economy as it officially states, or whether it considers the TLTRO to simultaneously serve the secondary goal of providing negative rate relief to banks as well.

This article originally appeared on

Can data-based lending improve inclusion and reduce economic volatility?

Tech platforms make their credit assessments based on different data than banks traditionally tend to do. Recent research finds that this could have profound implications on access to credit, credit risk, monetary policy and the economic cycle

The basics of credit are the same, always, everywhere

The essence of getting credit, from an economic perspective, is as old as humanity. A borrower obtains funds, and promises to pay them back some day. But the deal suffers from “asymmetric information”. The lender knows less than the borrower does about e.g. the borrowers intentions, his behaviour, the risks he faces. So the lender wants to see proof of income, looks at the prospects of the economy the borrower is operating in, and draws from experience with similar borrowers in the past.

The essence of getting credit, from an economic perspective, is as old as humanity.

Based on all that, the lender demands a risk premium: a markup on the interest charged, as an insurance premium against losses incurred should the borrower be unable to repay. The premium can be lowered if the borrower is able to pledge collateral: assets, such as a house, the lender can repossess if things go wrong. This basic process is true for banks, but also for markets, where the rates on collateralised loans and bonds tend to be lower than those on unsecured ones.

Current bank and market lending systems do have their downsides

This basic mechanism tends to work reasonably well, but it does have a number of side effects.

1. A minimum amount of financial data is needed to assess credit risk

At the individual level, borrowers that do not have a multi-year history of stable income to show, or a valuable asset to pledge as collateral, may find it more difficult and expensive to obtain credit. As such, self-employed people with volatile incomes and start-up entrepreneurs may find it more difficult to obtain credit

2. At the macro level, the system amplifies the economic cycle, for better and for worse

When the economy grows, lenders will make a more favourable assessment of borrowers’ chances to repay their loan. Retail clients are more likely to retain their job and get wage increases, while SMEs are more likely to prosper and grow. If real estate prices increase, this increases the value of the collateral borrowers can pledge. More borrowers will be able to obtain more credit. This, in turn, increases spending power in the economy, reinforcing the upward cycle of GDP growth and increasing real estate prices. However, once the cycle turns, this self-reinforcing mechanism goes into reverse. Borrowers’ prospects deteriorate, and with it, lenders’ willingness to lend to them. Moreover, if real estate prices fall as well, lower collateral valuations reduce the amount of credit a borrower can obtain. This process has been analysed as the “financial cycle” and, earlier on, as the “financial accelerator mechanism”.

If only there were a way to reduce the asymmetry of information. If the lender were able to get a real-time and thorough understanding of the borrower’s business, the need to assess broader economic conditions might be lowered, and collateral requirements might be relaxed or even removed completely. This would enhance access to credit and reduce the procyclical tendencies embedded in both bank and market lending today. But how, you say?

Credit based on alternative, non-financial data to the rescue?

Scoring based on “non-traditional data” is already as good as, or even better than, traditional ratings.

This is where tech platforms come in. They gather data on their users’ interactions and transactions on the platform, and often beyond. Their users tend to spend a lot of time on those platforms, (including site and app, but also e.g. partner websites). Based on the profile they build of their users, platforms can make real-time credit assessments, and may feel comfortable e.g. extending consumer credit to buyers, but also lending to merchants active on the platform. Recent BIS analysis shows that such credit scoring based on “non-traditional data” is already as good as, or even better than, traditional ratings.

On the one hand, such profiling may sound creepy, and indeed there are trade-offs to consider, especially in terms of privacy. Policymakers in Europe and elsewhere continue to review data use developments and applicable regulations. But on the other hand, real-time credit assessments made based on data gathered about interactions and transactions may extend credit and other financial services to new groups that were previously excluded, because of lack of a stable income history or lack of collateral to pledge.

There are trade-offs to consider, especially in terms of privacy.

That is a welcome development in a world where temporary and self-employment become more prevalent, and where digital markets invite entrepreneurship. Moreover, analysis of “non-traditional” data allows lenders to provide borrowers with more timely, personalised and accurate tools to monitor their financial situation and loan obligations. This should benefit both borrower and lender.

For the economy at large, loosening the relationship between economic conditions, real estate valuation and credit may reduce procyclicality. A recent BIS paper studying bigtech credit in China, shows that indeed, the correlation with real estate prices and GDP is lower for bigtech credit than it is for credit assessed on a traditional basis, which suggests this form of credit should be less procyclical.

Tapping new sources of data is not the exclusive domain of fintech and bigtech

While bigtech credit thus far is not the dominant form of borrowing in most economies, and plays only a minor role in Europe, this will change, and possibly faster than many currently anticipate. See e.g. this recent FSB report about how bigtech is expanding its finance offering in emerging markets. Of course, it’s not just bigtech firms that can lend using “non-traditional data”. Other lenders may also rely on data-crunching credit assessment by platforms in an originate-to-distribute setup – this is the way China’s Ant Group works together with banks.

Any lender can develop the analytical capability and expertise to use alternative data, provided they have access to them.

Apart from relying on other companies’ expertise, any lender can try to develop the analytical capability and expertise to use non-traditional data, provided they have access to them. Not every lender will be in a position to develop a platform of their own, where buyers and merchants generate enough data to make meaningful credit assessments. But of course lenders could also access data from other platforms, for example by entering into a bilateral partnership with the platform. Alternatively, regulation could be designed to enforce data portability, allowing borrowers to give lenders access to platform data they have generated. Incidentally, policymakers such as the European Commission indeed recognise the value of data and data sharing for financial services and beyond. Policies enforcing more wide data sharing – all subject to user permission – are being actively explored.

To put things into perspective: platform data-based borrowing will not solve all financial exclusion and procyclicality problems overnight. It may help to reduce information asymmetry between borrower and lender, but will not fully eliminate it. Moreover, the future always holds risk and uncertainty that even the most advanced algorithm fed with the most up-to-date data cannot foresee – a lesson we have again learnt in 2020. But the addition of a platform-based credit channel could certainly help enhance credit access and financial and economic stability. Moreover, a less cosy relationship between real estate prices and credit would be a welcome development both for credit markets and associated risks, and for housing markets and affordability.

This article originally appeared on

EBF-panel Tech meets Finance

With the year 2020 dominated by Covid-19-related restrictions of physical interaction and an increasing relevance of technology and digital interaction for businesses and citizens, legislative initiatives by the European Commission aim at addressing digital transformations in Europe’s economy. Technology actors, i.e. BigTech, are expanding their reach from their core businesses into adjacent industry sectors. In turn, the European market is increasingly facing questions of competition, market conditions and available digital infrastructure. The financial sector is a frontrunner in the application of digital innovation to the benefit of customers and business operations. Consequently, the financial ecosystem meets newcomers who – thanks to possible gatekeeper roles –carry significant changes into the known environment of business relations and regulatory framework.

PANEL DEBATE: Innovation in finance – digital platform solutions

How are European banks, regulators and tech companies perceiving these changes? With the European Commission’s Digital Services Act coming up, the conversation will touch upon the role for new ex ante regulation and the protection of fair competition and innovation required for a prosperous Europe.

  • Pablo Urbiola Ortún, Head of Digital Regulation and Trends, BBVA
  • Elisabeth Noble, Senior Policy Adviser, EBA
  • Jan Boehm, European FinTech Association
  • Teunis Brosens, Head Economist for Digital Finance and Regulation, ING

Moderated by: Sébastien de Brouwer, Chief Policy Officer, EBF

CBDCs and commercial banks: Evolution or Revolution?

As countries around the world accelerate the development of retail central bank digital currency, the impact on commercial banks and their role in this endeavour remain uncertain. OMFIF’s Digital Monetary Institute convened a panel discussion to explore what a retail CBDC public-private partnership would look like and how this would shape banks’ business models.

The panel included Hanna Armelius (Riksbank), Henny Arslenian (PWC), David Birch, and me. We discussed the potential division of labour between central banks, commercial banks and technology companies, and assessed how non-bank providers’ participation in a CBDC roll-out could impact traditional banks’ strategy and operations, as well as wider implications for global banks if digital currency is adopted for cross-border payments.

Tellingly, at the start of the seminar 78% of the audience thought the benefits of CBDC would outweigh the risks posed to the commercial banking sector, but this had dropped to 61% by the end of the webinar.

The consensus view among panelists was that central banks could distribute digital currencies through banks, in a public-private partnership not unlike the way the distribution of physical cash is organised. This would be a less disruptive scenario for banks and for the financial system more broadly, although availability of deposits would remain an issue for the supply and pricing of credit to businesses and households. While preserving banks should never be a policy goal, preserving financial stability while introducing CBDC should be. This does not mean a no-go for CBDC but does imply a reality check, and a warning to proceed carefully.

 Sources: ING THINK, OMFIF DMI, video registration. 

How Covid-19 is drastically changing digital finance

Digital finance was already a fast-changing place before Covid-19. After the pandemic, expect more government intervention. A changing appreciation of data may have strong implications for finance as well.

The Covid-19 pandemic will eventually pass, but not before disrupting vast swathes of the global economy and making its mark on digital finance.

1. Bigger government role

The increased role of government in the economy and financial sector is likely to persist to some degree. Before Covid-19, the changing geopolitical landscape had already made policymakers aware of the strategic importance of vital domestic infrastructure, including communications and payments. Governments are now also looking into data, an area already identified as a strategic priority by the European Commission earlier. In finance, governments have quickly established huge guarantee schemes to see businesses through the crisis.

It will take years to wind down the increased public role in finance 

Even in a best case scenario, it will take years to wind down this increased public role in finance and the broader economy. A renewed debate on the division of labour between public and private sectors in finance will likely flare up, once the dust settles.

2. Reduced foreign dependence

Calls for autarky (e.g. in producing face masks) may fade quickly, but both businesses and authorities will look for less complex cross-border supply lines and smaller foreign dependencies, as Covid-19 demonstrates their fragility, but also on national security grounds. At the same time, governments have also been made acutely aware of the need for high quality communications infrastructure, e.g. to facilitate working from home. Countries with leading positions in the required technologies (think China and 5G) will be aware of their good negotiating position.

Authorities realise digital platforms are playing useful roles in locked down societies.

Finance  has grown into a business with complex cross-border linkages. This ranges from financial ties to IT outsourcing and supervision. These international, sometimes global linkages, were already critically scrutinised by authorities, a development that may intensify post-Covid-19. How bigtech’s endeavours in finance fit the revised picture, remains to be seen. National authorities e.g. in Europe were increasingly critical about bigtech before the pandemic struck, but also realise that major digital platforms have become an important part of daily life and are playing useful roles in locked down societies.

3. Cybersecurity

The switch to working from home has stretched across corporate and national network infrastructures. With resources reallocated to keeping the show on the road, this exposes businesses (and an already heavily burdened health care sector) to increased cybersecurity risks, such as ransomware attacks and data leaks, but also to things like fake news. We have to reckon with the possibility that bad actors use security gaps today to establish a presence, only to exploit this presence later on, when it suits them best. To counter this threat, cybersecurity may be expected to move up the policymakers’ agenda. Given that cybercrime knows no borders, it is best fought at the international level. In the EU, while there is an EU agency, there is no deep cooperation as in markets and finance, for example. That might change in the future.

4. Faster adoption of digital interactions in retail

On the retail end, we expect the adoption of digital finance technologies to accelerate post-Covid-19. Many people have had no other choice than to acquaint themselves with ways to do business digitally – ranging from video conferencing to exchanging documents securely by digital means, or paying contactless to minimise physical contact.

Identity verification via video call may become accepted practice rapidly

We expect identity verification via a video call to become accepted rapidly. In the medium term, this may provide a boost to digital-only financial intermediaries, and may accelerate the demise of brick-and-mortar financial shops.

5. Focus on inequality and financial inclusion

The pandemic has put new focus on inequality in society. Digital financial intermediaries may be asked to intensify their efforts towards financial inclusion, e.g. by improving access to financial products for groups such as the self-employed, temporary workers and small and medium-sized enterprises (SMEs). Access for these groups is hindered by the limited availability of financial data and the high costs of processing them. One way to go about this is to augment financial data with a diversity of non-financial data sources.

6. Changing attitudes vis-à-vis data

Until recently, data debates centred around things like privacy and the question of whether people are comfortable paying for platform services with their data. While people may not like the idea when they think about it, in practice they continue to use said services. Several European governments are currently considering tracking location, health and other personal data for Covid-19 control monitoring and personalised health advise (e.g. to self-quarantine). There are other examples where data sharing could be useful in a lockdown society. Acutely arising liquidity needs due to the lockdown have demonstrated the need for quick credit checks. In the absence of readily available financial data, alternative (platform) data may prove very valuable.

People may reconsider the potential gains of sharing data and the need to protect users and society at large from data abuse

While data protection and usage monitoring remain paramount, far-reaching data sharing may be temporarily acceptable to most given the challenge at hand. But after the pandemic too, people may reconsider the value of data, the potential gains of sharing this data and the need to protect users and society at large from data abuse. Such shifting views may in turn enable new business models such as data guardians (a function that prima facie banks might be in a good position to fulfil), and may accelerate the establishment of legal frameworks to govern data sharing and protection.

Conclusion: Don’t stop thinking a step ahead

The coronavirus pandemic is such a fundamental and monumental shock that it will have a lasting influence on digital finance. In particular, and in no particular order, we see shifts in the relationship between the public and private sector in finance, changes to global interconnectedness, the need for increased cybersecurity cooperation, an acceleration of digitisation, an increased focus on financial inclusion and shifting attitudes towards data. For both financial intermediaries and policymakers, it is wise to start thinking about these tectonic shifts too.

 This article first appeared on ING THINK