Lombard Rate Essay ⋆ Business Essay Examples ⋆ EssayEmpire

The Lombard rate used to be a key interest rate in Germany, although such rate existed in France, Belgium, and Switzerland as well. The Lombard rate was the interest rate charged by the German central bank, the Bundesbank, for very short-term loans made to commercial banks against collateral securities that were marketable and easily convertible into cash. The loan helped commercial banks to deal with temporary shortage of funds. With the introduction of the euro in Germany, the Lombard rate has lost much of its importance and has since been replaced by the European Central Bank’s marginal lending rate.

In effect, the Bundesbank had two rates at which it could make loans to banks—the discount rate and the Lombard rate, with the latter being higher than the former. For this reason, banks would first borrow at the discount rate. However, the extent of borrowing at the discount rate was limited by borrowing quotas. Hence, for additional financing, the banks would borrow at the Lombard rate.

In the past, the Lombard rate was a major instrument in Bundesbank’s monetary policy. For example, following the era of German reconstruction after World War II, the Bundesbank increased the Lombard rate in the mid-1960s to curb inflationary pressures. Similarly, to curtail excessive currency speculation under the Bretton Woods system, the Bundesbank increased the Lombard rate in the early to mid-1970s to make it more expensive to borrow the German mark, the currency of Germany prior to 2002. However, in the mid to late 1970s, the rate was cut appreciably to counter recession. During the 1992–93 exchange rate mechanism (ERM) crisis, the Bundesbank lowered the Lombard rate repeatedly to mitigate the effects of the crisis. Starting 1999, the Bundesbank does not report the Lombard rate.

Prior to the introduction of the euro, the Bundesbank was regarded as an important one in the European Community (EC), now the European Union (EU). Hence, changes in the Lombard rate would make headline news across Europe, and speculation about changes in the rate prior to Bundesbank meetings was rife. Changes in the Lombard rate would also affect stock prices and the German mark exchange rate. However, in the late 1990s and with the euro replacing the German mark in 2002, the significance of changes to the Lombard rate decreased considerably as the Bundesbank used other mechanisms to control the money supply, for example, using the security repurchase agreements. The frequency of changes to the Lombard rate declined in the 1990s, just like the implications of the changes. The changes were interpreted as being technical rather than nontechnical, i.e., the change did not convey information about the Bundesbank’s stance on monetary policy, but served as a mere realignment, for example, to match the increase in the repo rate. With the advent of the euro, monetary policy powers were transferred from the Bundesbank to the European Central Bank (ECB). As a result, the ECB’s marginal lending rate assumed the role of the Lombard rate. Accordingly, changes to the Lombard rate have not been set since 1999.

Bibliography:

G. Booth, F. R. Kaen, G. Koutmos, and H. C. Sherman, “Bundesbank Intervention Effects Through Interest Rate Policy,” Journal of International Financial Markets, Institutions and Money (v.10, 2000);
R. Kaen, H. C. Sherman, and H. Tehranian, “The Effects of Bundesbank Discount and Lombard Rate Changes on German Bank Stocks,” Journal of Multinational Financial Management (v.7, 1997).

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