Stylianideslaw

The explosive rise of interest rates during the last year seems indeed unprecedented. Since 21 July 2022, when the Governing Council of the European Central Bank (hereinafter called “ECB”) announced the first increase of one of the key ECB rates – the interest rate on the main refinancing operations (MRO), by 50 basis points setting it to 0,50% with effect from 27 July 2022, in approximately a year the said interest rate has risen to 4,25%, with increases being announced roughly every 6 weeks. By the latest announcement of the Governing Council of the ECB on 27 July 2023, the interest rate on the main refinancing operations, was raised by 25 basis points and has been set to 4,25% with effect from 2 August 2023. According to the said announcement “Inflation continues to decline but is still expected to remain too high for too long. The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner”.

It should be noted that the said rate was set at lower than 100 basis points (1,00%) on 11 July 2012, reached almost zero floor (0,05%) on 10 September 2014, and then indeed zero floor on 16 March 2016 where it remained since.

What is the main refinancing operation interest rate?

As defined by ECB, this is the interest rate banks pay when they borrow money from the ECB for one week, while offering collaterals as guarantee for the repayment.

How does it affect borrowers?

The interest rate based on which the interest a borrower has to pay when borrowing money is calculated, usually consists of the base rate and the margin, where in case οf a non-performing loan, a default interest rate may also be applied. The ECB main refinancing operation interest rate may form the base rate or may be used for the calculation methodology of a bank’s base rate.

Indicative example of how a monthly loan instalment with the ECB main refinancing operation interest rate being its base rate has been affected:

01 July 2022

01 September 2023

*For the above indicative example, the capital amount of the loan is €200.000 and the maturity of the loan is 30 years.
The above calculations cannot be fully accurate and were made for the purposes of the indicative example for this Article only.

It should be noted that very recently, local banks announced some reward schemes for eligible customers with housing loans with variable base interest, including among others those with the ECB main refinancing operation interest rate. Quite interesting is also the fact that lately there has been a discussion about levying a windfall gains tax on banks for unexpected earnings or profits above average. If this is adopted, it will interestingly remain to be seen whether banks will eventually decide to lower their earnings by decreasing their interest rates on lending or by increasing their interest rates on deposits.

It also remains to be seen whether the ECB will continue to raise its key interest rates, including the main refinancing operation interest rate, as a measure to tackle inflation, and up to what level will that rise go. It will also be interesting to see whether Cyprus will seek to refrain from any more increases or even attempt to tackle the increases that have been already enforced, either by regulation or by measures taken individually by banks and credit acquiring companies as an initiative to limit the risk of explosion in numbers of non-performing loans.

Rafaella Georgiou
Advocate