Lombard Rate – Definition

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Lombard Rate Definition

The term Lombard rate has been used globally by people in various sectors to refer to the interest rate used by the central bank – Bundesbank.

Moreover, the term Lombard credit refers to the credit given to other banks by the Bundesbank against the pledges presented. These pledges are mostly life insurance policies or securities. In this type of transaction, the security item must be readily marketable to guarantee the security interest.

Following the introduction of the Euro currency, the ECB has used the term “marginal lending rate” to mean the same thing.

A Little More on What is Lombard Rate

The term Lombard originated from the individuals who conquered and settled in the northern part of Italy known as Lombardy.  The term is also used in the Europe for the bank rates by the central bank when giving out loans to other banks. Lombard loans simply mean a secured loan whereby a deposit secures the whole loan amount.  These deposits include the money in the bank accounts, insurance policies, bonds or any other asset that can be used as security a loan. The loan is based on varying terms from one country to another. for example, in Switzerland, the Lombard loan is even possible without a fixed loan term.  This gives the borrower an opportunity to decide the time they would like to pay back their loans. The Switzerland banks have set a minimum loan security requirement that ranges from 25, 000 to 100, 000 francs. The maximum Lombard loan that the borrower can get varies depending on the profile of the borrower to the bank. This loan is widely in Switzerland in the investments and security trading.

History of the Lombard loans.

The origin of term Lombard can be traced to the middle ages and mostly the banking system that was used by the merchants from the Italy especially from the Lombard region.  Due to economic expansion and increased trading of the west especially around the 12th century, these merchants are the first people to introduce the loans to the customers the act that was later adopted by the banks as a profession. The Lombard loan provides that the assets must remain invested. However, the borrower retains all the rights and benefits related to the invested asset such as dividends for equity holdings and voting rights. In this regard, the borrower does not need to reduce their potential returns or capital to secure the loan. Nonetheless, there was accost that was charged on the borrower when they seek to obtain loans from the bank. The cost of the loan depends on the amount of money borrowed from the banks, the length of the time to repay the loan, and the quality of the collateral used to secure the loan.

References for Lombard Rate

Academic Research on Lombard Rate

The effects of Bundesbank discount and Lombard rate changes on German bank stocks, Kaen, F. R., Sherman, H. C., & Tehranian, H. (1997). Journal of Multinational Financial Management, 7(1), 1-25. This paper examines whether the changes in the interest rate of the Bundesbank provides the investors with the information regarding economic conditions and financial markets in the future. This study mainly focuses on the impacts of these economic conditions and financial markets on banking and bank equities. It was discovered that an increase in the Lombard rates and Bundesbank discount are accompanied by negative abnormal returns on German equities. It was also noted that negative market improved abnormal returns on stocks of the bank. The paper also pointed out that the reduction in official rates is accompanied by positive market-wide returns. Bank stocks and abnormal returns are adjusted by a positive market. The paper concluded that changes in Lombardy rates and discount on Bundesbank are systemic events that guide investors in the revaluation of cash flow.

The Experience of Mauritius with the Lombard Rate: An Overview, Punchoo, V. (2004, April). In Stakeholders’ Forum on Financial Sector Reforms, Mombasa, Kenya, April (pp. 15-17). This paper discusses the experience of Mauritius with the Lombard rate. According to the author, efficient financial management needs a deep and efficient market. The Effective indirect monetary management requires a deep and efficient money market. There is underdevelopment of the short-term money and treasury bills despite market-oriented reforms that were launched more than ten years ago.

Signalling with official interest rates: the case of the German discount and lombard rate, Anker*, P., & Wasmund, J. (2005). The European Journal of Finance, 11(1), 17-31. The European central bank relies on the standing facilities that act as its major operating procedures. The feature of the central bank of Europe provides that the official rates also form part of the signaling function. In this regard, this paper examines whether the signalizing of the official interest rates convey the information that is not available in other policy measures.  It also examines whether the outcomes of the revision expectations are effective.

We investigate whether Bundesbank interest rate changes convey information to investors about future financial market and economic conditions, especially as they …, Kaen, F. R., Sherman, H. C., & Tehranian, H. (1997). Journal of Multinational Financial Management, 7(1), 55-70. This paper explores whether changes in the interest rate of the Bundesbank provide information to the investors regarding the economic and future financial conditions. It mainly focuses on the impacts on the banking and bank equities. From the study, it was discovered that the rise in the Lombardy rates and Bundesbank discount arise from negative abnormal returns on Germanic equities. Negative market adjusted abnormal returns of the bank stocks. In conclusion of the study, changes in Lombard rates and Bundesbank discount are systematic events that guide the potential investor on revaluation of cash flows.

Banks’ demand for reserves when future monetary policy is uncertain, Nautz, D. (1998). Journal of Monetary Economics, 42(1), 161-183. This paper examines the demands for the reserves by the banks when the future monetary policy is unknown. In this study, the author presents that the use of significant use of revolving securities buy-back agreements has enhanced the flexibility in the management of the monetary markets of many central banks under the European nations. The paper presents that flexibility of the central banks has considerable influence on money market conditions. It was revealed that the uncertainties of the future monetary markets reduce the demand for the reserves by the banks.

Exchange rate stability and managed floating: the experience of the Federal Republic of Germany, Artus, J. R. (1976). Staff Papers, 23(2), 312-333. This paper examines the links between private monetary capital flow, short-term interest rate and the rate of exchange in the managed floating system. According to the author, many economics argue that the capital flows have effects that prevent erratic exchange rates from occurring.  The paper also analyses the probable implications of the central monetary authority intervention to both forex and domestic monetary markets.

Interest rate based forecasts of German economic growth, Harvey, C. R. (1991). Weltwirtschaftliches Archiv, 127(4), 701-718. This paper the impacts of interest-based forecast on the economic growth of German. According to the author, forecasts based on interest rates provide an accurate forecast on the economic growth with regard to the interest rate and economic growth. The author also presents that interest rate model offers lower estimates compared to the other forecast models used in the economy.

Interest rate spreads as predictors of German inflation and business cycles, Ivanova, D., Lahiri, K., & Seitz, F. (2000). International Journal of Forecasting, 16(1), 39-58. This paper studies various factors regarding the spread of interest rate predictors of the German inflation and business cycle in the post-Bretton Woods era. The study discovered that the term of the bank structure, term structure of the public and the spread based need a critically analyzed and predicted recession that has the effective lead.

The response of stock prices to changes in weekly money and the discount rate, Hafer, R. W. (1986). Federal Reserve Bank of St. Louis Review, (Mar), 5-14. This paper examines various aspects regarding the hypothesis of the efficient markets. The authors seek to answer some questions regarding the impacts of changes in the stock prices to the monetary and discount rates.

Anticipation and surprises in central bank interest rate policy: The case of the Bundesbank, Hardy, D. C. (1998). Staff Papers, 45(4), 647-671. The interpretation of a signal of future policy is dependent on the extent to which the transformation is anticipated which in turn market reaction to a change in official interest rates. This paper develops a technique that distinguishes anticipated and unanticipated parts of such transformations. This technique is also used to estimate the response of Euro-Dutch mark interest rates to modifications of in the Lombard interest rates and Bundesbank. The outcomes put to the spotlight the efficiency of this market and the possibility for policy signalizing by the central bank.

Do central banks react to the stock market? The case of the Bundesbank, Bohl, M. T., Siklos, P. L., & Werner, T. (2007). Journal of Banking & Finance, 31(3), 719-733. This paper questions before the European Central Bank assuming responsibility for the monetary policy of 199 whether Bundesbank reacted systematically to stock price movements. The empirical findings of this paper also indicate that there was a weak relationship between German stocks and interest rates that are short term at daily and monthly frequency. This is contrary to the findings on the results of the US.

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