who gets the extra interest?

easyontheeye

hi,

I dont know alot about how banking works. When the ECB decide to raise interests rates and this is then passed down to say a homeowner in ireland that has a mortgage with e.g. BOI. Where does the extra money go from this interest rise? who gets it? does it go to some sort of EU exchequer (does one exist)?

cheers

Économiste Monétaire

The rate increase goes to the ECB. The interest rate is the cost of borrowing not just for regular customers but for commercial banks too.

jon1981

Do national banks also borrow from the ECB? so even if say BOI never borrowed money from the ECB for 1000 morgages, the ECB hike would still apply on all those mortgages.

Économiste Monétaire

BOI is a commercial bank so yes they borrow from the ECB (through NCBs). It's how commercial banks get Euros (liquidity). It's usually the cheapest form of liquidity.

Flamed Diving

The ECB has a discount window where they release a certain amount of liquidity at auction. The rate that they wish to set is announced and the banks bid for this liquidity, in competition with each other. The hope of the CB is that if banks buy money at a certain rate, that they will lend it to their customers at a low interest margin. Although this is not guaranteed, which is why you may notice some banks holding firm despite ECB movements.

nesf

For all intents and purposes the ECB rate is the floor at which banks can lend to each other and get loans from the national central banks. Banks are constantly lending to each other and taking out overnight loans etc from the central banks.

An increase in mortgage rates might seem initially like something banks would like to do because they'll bring in a larger monthly payment but in reality if given the choice in the present market most banks would probably prefer it to stay the same. A higher interest rate increases the cost of them doing business on the money markets, it increases the chance of default for people close to the maximum of what they can afford each month and it dampens demand for new mortgages in an already slack market to just pick a few negative implications. The thing is, the money that's loaned out by the banks as mortgages needs to come from somewhere.

The day when banks sourced the vast majority of their funds from deposit accounts are over essentially, and banks source a fair percentage (40% to 70+% depending on the bank) of their funds from the money markets (and the cost of this is to a very large extent based around the ECB rate). Some banks are far more vulnerable to this than others, for instance Permanent TSB sources far more of its funds from the money markets than say AIB (iirc) and they will feel the pinch far more than AIB with a rate raise like this (and partially it explains their much higher rate, though average customer credit rating etc would be another factor).

Flamed Diving

nesf wrote: »

For all intents and purposes the ECB rate is the floor at which banks can lend to each other and get loans from the national central banks. Banks are constantly lending to each other and taking out overnight loans etc from the central banks.

An increase in mortgage rates might seem initially like something banks would like to do because they'll bring in a larger monthly payment but in reality if given the choice in the present market most banks would probably prefer it to stay the same. A higher interest rate increases the cost of them doing business on the money markets, it increases the chance of default for people close to the maximum of what they can afford each month and it dampens demand for new mortgages in an already slack market to just pick a few negative implications. The thing is, the money that's loaned out by the banks as mortgages needs to come from somewhere.

The day when banks sourced the vast majority of their funds from deposit accounts are over essentially, and banks source a fair percentage (40% to 70+% depending on the bank) of their funds from the money markets (and the cost of this is to a very large extent based around the ECB rate). Some banks are far more vulnerable to this than others, for instance Permanent TSB sources far more of its funds from the money markets than say AIB (iirc) and they will feel the pinch far more than AIB with a rate raise like this (and partially it explains their much higher rate, though average customer credit rating etc would be another factor).

Correct, they are by far the biggest utiliser of such windows in Ireland, it think as high as 66%.