Euro. Picture: REUTERS/DADO DUVIC
Euro. Picture: REUTERS/DADO DUVIC

Related articles

In this article

FRANKFURT — One week before a long-awaited stimulus decision, European Central Bank (ECB) officials are privately deliberating over how to enhance their monetary policy stance without maiming its transmission.

Committees studying how to mitigate the effect on banks have prepared potential measures that range from variations on a tiered deposit rate to techniques for countering the effect of stimulus on excess liquidity, according to people familiar with the discussions. The suggestions could still be rejected by the executive board or turned down at the governing council’s March 10 meeting. An ECB spokesman declined to comment.

With eurozone inflation once again below zero and concern mounting over the state of the global economy, ECB president Mario Draghi and his colleagues are considering whether monetary policy needs to give more impetus to the currency bloc’s recovery. The chief concern is that negative interest rates, especially if cut further, might squeeze banks’ profitability to the extent they pull back on lending to companies and households.

Mr Draghi "should worry about the implications for the banking system", Mark Burgess, chief investment officer for Europe, the Middle East and Africa at Columbia Threadneedle Investments, said on Wednesday. "He needs a healthy banking sector."

One of the most straightforward measures would be to cut the deposit rate from the current minus 0.3%, while implementing a two-tier system. Banks would pay the negative rate only on the portion of their funds parked at the ECB that exceeds a certain threshold.

Such a facility, similar to that used at other central banks with negative rates, including the Swiss National Bank, would be simple to implement in the eurozone, the people said, asking not to be identified as the discussions were private.

While the Frankfurt-based ECB has operated a deposit rate below zero since mid-2014, it so far has not taken any direct steps to offset the potential hit to bank profitability.

A reduction in the rate of at least 10 basis points is fully priced in by investors, data compiled by Bloomberg indicate, based on swaps on the euro overnight index average.

ECB aware

The problem for financial institutions is that they cannot easily pass the cost of holding overnight cash at the central bank onto their customers for fear that they will withdraw their savings. Bank stocks have sold off this year, partly on the concern that more negative rates are on the way.

That is something for the ECB to consider as officials head into a self-imposed quiet period that starts on Thursday.

"We are well aware of this issue," executive board member Benoit Coeure said on Wednesday. "We are monitoring it on a regular basis and we are studying carefully the schemes used in other jurisdictions to mitigate possible adverse consequences for the bank lending channel."

Another technically straightforward option for the ECB would be to increase its monthly bond purchases under quantitative easing (QE). The central bank currently pledges to spend €60bn a month on public and private debt until the end of March 2017, a total of at least €1.5-trillion.

Cost burden

Yet that programme, along with targeted long-term loans (TLTROs) to banks, is generating large amounts of cash that have to be parked somewhere. Excess liquidity in the eurozone has risen to more than €700bn from less than €150bn a year ago when quantitative easing started. Under the negative deposit rate, those excess funds become a cost burden for banks.

The ECB was considering various options to make sure banks were not penalised for the extra liquidity and slow lending, one of the people said. One route could be to set the threshold for the tiered deposit rate at a multiple of banks’ required reserves — banks could be paid an interest rate equivalent to the main refinancing rate, currently 0.05%, on that amount, the official said.

"One easy way is to decide that all extra cash received from the ECB from TLTROs will not be subject to negative rates, meaning it will be treated as required reserves and not as excess liquidity," said Frederik Ducrozet, an economist at Banque Pictet and Cie in Geneva. "You need to find a way to increase the share of bank reserves which are not subject to negative rates and make sure credit expansion remains on track."

‘Zero sum’

Negative rate policies have garnered increasing market criticism in recent weeks, and were singled out by Bank of England (BoE) governor Mark Carney in a speech in Shanghai last week. He said they helped to spur the "zero sum game" of currency wars.

Mr Coeure defended the loose monetary stance, saying banks and the economy would have been worse off without it. The challenges facing the eurozone were highlighted in a purchasing managers survey published by Markit Economics on Thursday, which showed manufacturing and services companies cut prices in February.

"The eurozone is still recovering from a once-in-a-generation economic and financial crisis that has left deep scars," Mr Coeure said. "Both policy makers and financial institutions need to play their part. They need to ensure that the financial system is fit for purpose and able to finance the recovery — and they need to do so today, not tomorrow."

Bloomberg