German banks are facing a challenging situation. After enduring decades of low interest rates, they finally begin to earn substantial profits due to the interest rate shift, enabling them to offer substantial payouts to their shareholders. However, ECB policymakers introduce the notion of not only eliminating interest on the minimum reserve but also raising the minimum reserve rate, thereby cutting into the banks' profits.

It is clear that this idea doesn't sit well with the banks. The relevant lobby groups immediately raised alarm and warned that it could restrict the banks' lending capabilities. Banks see their profits slipping away. Commerzbank's CFO, Bettina Orlopp, even called the discussion "crazy". No bank manager has publicly expressed it so clearly before. Is it still sarcasm, or is it panic?

Hardliners in the ECB council have floated the idea of increasing the minimum reserve rate from the current 1% to as much as 10%. That would be quite extreme, especially since the rate has never been that high before. It has been at 1% since January 2012. Prior to that, a rate of 2% had been in effect since January 1999. If the ECB were to raise the rate even by 1 percentage point, it would burden the affected banks' pre-tax profits by around 4%, as calculated by an S&P analyst recently. Ouch! All of this is happening while the ECB had already decided last year to stop paying interest on balances exceeding the minimum reserve requirement, and in July, it completely abolished interest rates. According to Orlopp, Commerzbank alone is losing 100 million euros in revenue annually due to these changes.

So, what did the banks do? In September 2022, they massively shifted their balances with the central bank into the still-interest-bearing deposit facility. The volume of the deposit facility in the Eurosystem increased by €3.78 trillion, with approximately 1 trillion euros held exclusively by the Bundesbank. This money doesn't contribute to the real economy, yet banks earn risk-free interest from it. The discussion becomes political at this point. To what extent may and should the central bank use interest mechanisms to subsidize banks?

It's important to mention that the ECB had imposed negative interest rates of up to -0.50% on banks for years. From this perspective, compensation for the banks seems only fair. Nevertheless, it's also true that during this time, the ECB helped the banks through longer-term refinancing operations. Based on the latest monthly report from the Bundesbank, German banks incurred interest expenses of €4.8 billion in 2021 due to negative interest rates. In contrast, they also earned interest income of 4 billion euros from refinancing transactions with the Eurosystem. Last year, approximately 2.4% of the overall interest income of German financial institutions came from interest earnings related to the deposit facility and refinancing transactions with the Eurosystem.

Originally, the deposit facility was not designed as a risk-free interest income machine for the banks. It was actually intended for banks to park excess liquidity overnight at the ECB if the bank didn't see better investment opportunities for the money. Banks evidently don't seem to possess these profits, putting the ECB in a dilemma. After all, the ECB is not only responsible for monetary policy and has an interest in ensuring that its interest rate hikes have an impact on the real economy. It is also responsible for banking supervision and has an interest in the well-being of the banks. And banks thrive when they make high profits. The ECB must weigh how much it wants to continue subsidizing banks with risk-free interest earnings. Relying solely on banks to devise their own innovative methods to increase earnings would be quite impractical.