Lombard Rate What it Means How it Works

Lombard Rate What it Means How it Works

Lombard Rate: Understanding its Meaning and Function

The Lombard rate is the interest rate charged by central banks when extending short-term loans to commercial banks. Traditionally, it involves loans backed by specific collateral. The term originates from Lombardy, Italy, a region with a rich history of banking dating back to the Middle Ages. The Lombard rate is most commonly associated with the Bundesbank, the central bank of Germany.

Key Takeaways

  • The Lombard rate is the central bank interest rate used for short-term collateralized loans to central banks.
  • Its origins can be traced back to Italian banking houses in the Middle Ages.
  • Today, this term is less common but is still occasionally used in European and international banking contexts.

Historically, the Lombard rate was associated with the banking houses of Lombardy, Italy. These banking houses were known for their pledged collateral loans. The Bardi banking family, which originated in Lombardy, built the Compagnia dei Bardi banking house. They also operated a Paris office called the Maison de Lombard, which specialized in pledged collateral loans. These loans gained popularity throughout Europe, leading to the Lombard rate becoming a common term in the continent’s banking community.

In Germany, the Lombard rate became known as "lombardsatz" and was considered a significant financial market indicator. As Germany’s economic importance in Europe grew, the Lombard rate became a key financial metric in Europe.

In recent times, references to the Lombard rate have become less common, as the interest rates published by the European Central Bank (ECB) have taken precedence. However, some European countries still use the old terminology. For example, Poland continues to reference the Lombard banking tradition with terms such as "Lombard loans," "Lombard rate," and "Lombard facility."

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Today, the Lombard rate mainly applies to European banks and plays a similar role to the discount rate used by the U.S. Federal Reserve. In Europe, the Lombard rate is typically set about 0.50% above the Bundesbank’s discount rate.

Prior to the formation of the euro, Germany had the authority to control its own monetary policy, allowing it to adjust the Lombard rate as needed. However, now the ECB holds the authority for setting interest rates and guiding monetary policy.

Example Usage of the Lombard Rate

The term Lombard rate used to specifically refer to the interest rates on loans made by the German Bundesbank to its credit customers. Similar to the Italian banking houses of the Middle Ages, banks were required to pledge collateral securities to qualify for a Lombard loan.

In 1999, the ECB took over the task of setting the Lombard rate for European Union (EU) banks. The term Lombard rate was replaced with "interest rate on main refinancing operations" (MRO). Nevertheless, some countries both within and outside of the EU continued to use the term Lombard rate to refer to their central bank’s short-term lending rate to commercial banks.

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