ECB’s Sub-Zero Headache Might Require Range of Fixes to Be Fair

(Bloomberg) --

European Central Bank officials trying to make their sub-zero monetary policy more palatable may need to be imaginative if they want it to reach the whole euro zone.

While the ECB levies a deposit rate of -0.4% to stimulate the economy, charging banks to deposit money effectively curbs profits. So its staff are spending the summer looking at fixes to allow for a further interest-rate reduction.

A tiering system, applying more favorable terms to some deposits, is the most obvious approach, but the downside is that it might deliver a margin boost in the region’s core, without offering a lift in weaker economies. Banks in France and Germany are net depositors with the ECB. In southern countries such as Italy, they are generally net borrowers, but they suffer from low interest rates too.

“Tiering looks quite likely, simply because the ECB mentioned it so specifically, but I’m not sure whether it’s a silver bullet,” said Nick Kounis, an economist at ABN Amro Bank in Amsterdam. “It doesn’t address the squeeze between lending and deposit rates they’re facing. More generous long-term loans would make more sense if your goal is to get lower rates into the economy.”

Officials might have to deploy more than one fix if they want the benefits to be widespread, not least if they want to galvanize policy makers who are split on what to do.

Central bank staff from around the euro region are studying solutions, having been told by policy makers to get thinking. ECB President Mario Draghi is hoping to use the fruits of that process in a round of stimulus as soon as September.

What Bloomberg’s Economists Say

“We expect the ECB to cut the deposit rate by 10 basis points and relaunch its asset purchase program in September. This stimulus package would increase the costs of negative rates for banks by around 60%, raising the risks that this starts impeding the transmission of monetary policy. To mitigate the impact, the Governing Council is likely to exempt some deposits held at the central bank from the deposit rate.”

--Maeva Cousin
Read the complete ECB INSIGHT

“I was encouraged by the recent communication of the ECB saying that they are considering something like this,” Societe Generale SA Chief Executive Officer Frederic Oudea told Bloomberg Television last week. “They understand that if it lasts long, yes it can impact profitability.”

Hans-Walter Peters, president of the Association of German Banks, predicted in an interview this week that a 10 basis-point cut in the ECB’s deposit rate would impose almost 2 billion euros ($2.25 billion) a year in extra costs on euro zone lenders.

Forays by the central banks of Japan and Switzerland into softening the impact of negative rates may offer some inspiration to the ECB on what to do. Here’s a deeper look at the kind of measures officials might consider.

Tiering

In a tiered system, the ECB can apply a less negative rate to some of banks’ overnight deposits -- or completely exempt certain amounts from the charge. It’s a model successfully used by the Bank of Japan, whose three-tier design applies a zero rate to most funds and takes into account liquidity created by monetary-policy operations.

Given the ECB operates in a similar environment as the BOJ, with vast sums of money sloshing around in the financial system as a result of measures aimed at aiding economic growth, Japan may be good point of reference.

Draghi first cited tiering specifically as an option following last month’s policy meeting. There’s a 50% probability of the ECB shifting to such a regime, according to Peters, the German bank lobbyist.

Changing Terms

Banks in the periphery, which are more reliant on ECB funding, would benefit more from a change in the terms of an upcoming lending program, known as TLTROs. Policy makers set the rules for the new quarterly operations before the economic outlook clouded and raised the need for more monetary stimulus.

Economists from banks including ABN Amro and Credit Agricole have proposed more favorable rates on long-term loans as a solution.

Liquidity-Absorbing Operations

Other forms of bolstering bank profitability include issuing debt certificates, running liquidity-absorbing operations or increasing the amount of required reserves that isn’t subject to the deposit rate.

These options could be tailored to help banks across the region. The drawback is that they decrease the amount of money floating around freely, which could be understood as monetary tightening -- something the ECB would want to avoid at a time when it’s considering adding support.

More Remote Options

That leaves even more remote alternatives such as raising the interest on reserves required from lenders -- a step likely to have little impact -- or buying bank bonds, a move that would create a conflict of interest for the ECB, which is also the supervisor for the region’s biggest financial institutions.

--With assistance from William Horobin and Jeannette Neumann.

To contact the reporter on this story: Jana Randow in Frankfurt at jrandow@bloomberg.net

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Craig Stirling

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