European Banks Are Getting a Negative Vibe
Would you pay someone for the privilege of lending them money?
Euro-zone banks might soon face that conundrum. European Central Bank officials, grappling with low inflation and weak growth, are publicly considering taking the bank's deposit rate, now at 0%, negative. That means effectively charging banks to hold their money.
ECB President Mario Draghi this week faced questions about the possibility of negative rates, a move the central bank discussed at its latest policy meeting. But, even if the ECB takes such a radical step, it may find the euro-zone economic engine doesn't respond.
Central banks rarely set negative interest rates. Denmark's central bank adopted the tactic last year, mainly to support the krone's peg to the euro. The ECB's hope partly would be that charging banks for deposits would spur lending. European financial institutions have about €170 billion ($229 billion) at the central bank in excess of reserve requirements.
In theory, flush banks in Northern Europe would lend more to their southern European peers. That would stoke the interbank market and ease the flow of credit to businesses and households.
Negative rates might also prove an easier option for the ECB than enacting its own Federal Reserve-style bond-buying program. A policy of buying government bonds faces practical and political difficulties given the euro zone comprises 17 different countries. Negative rates, by contrast, could be seen as an extension of conventional policy, consistent with the ECB's role as the euro zone's lender of last resort.
The problem is how banks respond. Bankers themselves are skeptical about the likely effectiveness of such a move.
Regulatory issues could still prevent them lending more. Banks must now hold enough liquid assets like cash to cover their needs for at least 30 days. Cash they lend to other banks doesn't count toward that requirement, though, meaning negative deposit rates may not be able to stoke the interbank lending market.
Negative rates would also reduce banks' profitability, particularly in Germany, France and the Netherlands, whose banks collectively account for the bulk of ECB deposits. Banks would be reluctant to pass on the rate cut to their own customers; the first to do so might face the risk of customers withdrawing deposits.
To maintain margins, banks might have to raise lending rates, the opposite of the ECB's desired effect. Yet absent higher loan rates, negative deposit rates might serve only to weaken robust banks, with scant offsetting benefit.
Moreover, strong banks might still not be willing to lend to weaker ones given the lingering uncertainties over balance-sheet strength at many European firms. Banks with high deposits at the ECB might prefer the predictable hit from negative interest rates to the uncertainty associated with increased lending.
With memories of the euro-zone crisis so fresh, the ECB can't assume financial firms will quickly emerge from their bunkers.