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Lombard rates are interest rates charged by central banks to smaller lenders for loans, which they then pass on to borrowers. The rates are set slightly above the standard interest rate and are used to promote borrowing from the central government during times of financial instability. The US and Germany are the most recognized countries using the Lombard credit system. Critics argue that government intervention threatens private business sovereignty.
Lombard rates are the interest rates charged to banks for credit usually provided by a central government. In the most basic sense, lombard rates are set for the repayment of loans offered by a central bank to smaller lenders. These banks receive capital which, in turn, they lend to other borrowers, opening up credit on the market. To leverage the repayment claim, the central bank charges an interest rate to the bank which is passed on to the borrower, creating income for the bank. The guarantee comes in the form of financial securities and life insurance policies issued by the bank itself.
Lombard rates are usually set by the central government or bank at slightly above the standard interest rate. For example, if the monetary rate is set at five percent, the Lombard credit rate is set at six percent. The central bank charges the smaller bank XNUMX% interest on the loan, while the smaller bank turns around and charges its borrower XNUMX%. This means that the bank is making a profit, hedging against losses on the securities, and using these securities for lending. Pay off the loan with the low interest rate or be forced to supply the bonds to the central bank.
The two countries most recognized as operating with the Lombardy credit system are Germany and the United States. In Germany, the central bank issues loans to many financial institutions in order to preserve the economy by making credit available to businesses. In the US, this is maintained by the Federal Reserve System, a group of private banks working for the government. Both systems lend to institutions at lower rates than other banks will lend to each other.
During times of financial instability, the Lombard rate method is used in conjunction with discount rates set by the central government or the bank. If the discount rate is set at four per cent, the Lombard rate is set just below this figure. This promotes borrowing from the central government rather than from other banks. Unfortunately, when the discount rate is set close to zero, as is the case in extreme recessions, the Lombard rate almost becomes a moot point. Lending keeps almost the same cost from the central bank or private banks.
Critics of the system point to the trustworthiness of the federal government or central bank as a threat to the sovereignty of private business. When governments intervene in a country’s financial sector, it ceases to be alien to the economy. The balance between the central bank as “lender of last resort” and as primary lender in the financial sector is a delicate balance between the free market system and economic control by a central authority.
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