ECB push­ing euro-area banks to lend

The Pak Banker - - COMPANIES/BOSS -

De­posits at the ECB by euro-area banks in ex­cess of re­quired re­serves have jumped six­fold since the in­tro­duc­tion of neg­a­tive in­ter­est rates, while lend­ing within the cur­rency bloc has barely budged. Of the 646 bil­lion euros ($730 bil­lion) that banks added in as­sets dur­ing the pe­riod, about 85 per­cent has ended up as de­posits at the cen­tral bank. One rea­son banks are pay­ing to keep money idle is a lack of de­mand for loans in an econ­omy still re­cov­er­ing from a dou­ble-dip re­ces­sion and a sov­er­eign-debt cri­sis. An­other is that banks sad­dled with bad loans or low cap­i­tal lev­els and those in the midst of re­struc­tur­ing are re­luc­tant to in­crease lend­ing. Even the ECB's lat­est of­fer to pay banks in­ter­est on money they bor­row from the cen­tral bank may not do the trick.

"They're not prof­itable enough to sub­stan­tially in­crease lend­ing, so even the neg­a­tive rate for lend­ing by the ECB to the banks prob­a­bly won't help much," said Jan Schild­bach, head of re­search for bank­ing and fi­nan­cial mar­kets at Deutsche Bank AG in Frank­furt. "It's not lack of liq­uid­ity or its price that's the prob­lem."

Lend­ing to non­fi­nan­cial com­pa­nies and con­sumers, ex­clud­ing mort­gages, has been stuck at about 6.8 tril­lion euros since June 2014, ECB data show, de­spite the cen­tral bank's liq­uid­ity pro­grams to en­cour­age more of those loans. Pol­icy mak­ers have looked at those fig­ures when de­ter­min­ing how much cheap money to pro­vide lenders. Banks that in­crease such loans qual­ify for more funds.

When it went deeper into mi­nus ter­ri­tory on March 10, the ECB said it would use sim­i­lar cri­te­ria to de­ter­mine if a bank qual­i­fies for neg­a­tive rates on money it bor­rows from the cen­tral bank. That means the ECB is now will­ing to pay banks to bor­row at the same rate it charges for ex­cess de­posits they hold there. And it's will­ing to do so even if a bank isn't in­creas­ing lend­ing, as long as the firm is re­duc­ing lend­ing at a slower rate than in the pre­vi­ous 12 months.

"It looks like the ECB is just try­ing to stop the bleed­ing," said Sil­via Mer­ler, a fel­low at Bruegel, an eco­nomic re­search group in Brus­sels. "They've ba­si­cally done that with the pre­vi­ous liq­uid­ity pro­grams too. They haven't man­aged to en­cour­age more lend­ing, but at least stopped the ero­sion that was go­ing on."

Lend­ing within the euro area to non­fi­nan­cial firms and con­sumers, ex­clud­ing mort­gages, had de­clined by 627 bil­lion euros, or 8.5 per­cent, from June 2012 through May 2014. While neg­a­tive rates help Euro­pean com­pa­nies and con­sumers lower bor­row­ing costs, they are also squeez­ing banks' profit mar­gins. That's be­cause the in­ter­est banks pay savers, which track ECB short-term rates, typ­i­cally can't go neg­a­tive for fear that retail de­pos­i­tors will with­draw their money and keep it in cash at home. When loan rates keep fall­ing and de­posit rates are stuck at zero, the spread be­tween what the bank charges for loans and what it pays for sav­ings con­tin­ues to shrink.

"One of the rea­sons for the poor per­for­mance of the banks is the crimp­ing of their mar­gins due to neg­a­tive rates," said Alas­tair Ge­orge, in­vest­ment strate­gist at Edi­son In­vest­ment Re­search in Lon­don. "If banks aren't healthy enough to make more loans be­cause they can't make money, how can the rates be ef­fec­tive in boost­ing lend­ing?" In­stead of lend­ing at lower spreads to com­pa­nies or con­sumers in the euro area, banks have boosted de­riv­a­tives trans­ac­tions and in­vest­ments out­side the cur­rency bloc. They've also cut se­cu­ri­ties hold­ings as most govern­ment bonds have neg­a­tive re­turns.

If neg­a­tive rates per­sist, banks might have no choice but to start charg­ing in­ter­est on retail de­posits, said San­ti­ago Carbo-Valverde, a fi­nance pro­fes­sor at Ban­gor Univer­sity in the U.K. who has been study­ing in­ter­est-rate mar­gins and bank­ing prof­itabil­ity for two decades.

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