Lombard Rate

What Is the Lombard Rate?

The Lombard rate is the interest rate charged by central banks when extending short-term loans to commercial banks. Traditionally, it refers to loans that are backed by specific collateral. The term originates from the Lombardy region of Italy, which has a rich history of banking houses dating back to the Middle Ages. Today, it is mainly 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.
  • It originates in the Middle Ages from the activities of Italian banking houses.
  • Today, the term is less common, but it is still occasionally used in European and international banking contexts.

How the Lombard Rate Works

Historically, the Lombard rate was associated with the banking houses of Italy's Lombardy region, who were famous for their pledged collateral loans. Some sources tie the term's history to the Bardi banking family, which started in Lombardy and built the Compagnia dei Bardi banking house. This family also operated a Paris office known as the Maison de Lombard, which specialized in pledged collateral loans. These loans became popular throughout Europe, causing the Lombard rate to become a common term among the continent's banking community.

In Germany, the Lombard rate came to be known as the "lombardsatz," and was considered a key financial market indicator. As Germany's economic importance in Europe grew, the Lombard rate became one of the key financial metrics of Europe. 

In recent times, references to the Lombard rate have become less common, replaced by the interest rates published by the European Central Bank (ECB). However, the old terminology is still used by some European countries. For instance, Poland continues to reference the Lombard banking tradition in a variety of ways, with terms such as "Lombard loans," "Lombard rate," and "Lombard facility" remaining in common usage.

Today, the Lombard rate applies mainly to European banks, where it occupies a similar role as the discount rate used by the Federal Reserve in the U.S. In Europe, the Lombard Rate is typically set to 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, raising or lowering the Lombard rate at its discretion. This is no longer the case as the ECB holds the authority for setting interest rates and guiding monetary policy.

Example of the Lombard Rate

The term Lombard rate was formerly used to refer specifically to the interest rates on loans that the German Bundesbank, Germany's central bank, made to its credit customers. Similar to the Italian banking houses of the Middle Ages, banks were required to pledge securities in collateral in order to receive a Lombard loan.

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