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Europe is abuzz with a new expectation – that negative interest rates could be just around the corner. At meetings on the fringes of the European Commission and the Bank of England in recent days, word has it that officials are discussing the potential merits of such a policy.
This is more than idle chatter, too. Mario Draghi, European Central Bank president, indicated this month that a substantial minority of ECB council members now favoured a cut in the central bank’s main interest rate. Already at record lows, the ECB’s interest rates were last cut in the summer, with the main policy rate falling to 0.75 per cent and the rate of interest paid on money deposited with the bank cut to zero.
The idea is that by cutting those rates further – in essence charging banks to leave deposits at the ECB – lenders would be inspired to stop hoarding cash and inject it instead into stagnant economies, finally recharging growth in the process.
“Super Mario” himself seems dubious, warning that such a move would pitch the eurozone into “largely uncharted waters”. He has a point. But there are a few helpful non-eurozone precedents close at hand – in Sweden, which adopted the policy a few years ago, and in Denmark, which has negative rates now. In both cases, though, the strategy has been related to currency and foreign exchange concerns, rather than economic stimulus.
A similar stance has been taken up in recent weeks by Switzerland’s two biggest banks, though not the Swiss central bank. Credit Suisse and UBS both changed tack over the treatment of deposits from some institutional clients, charging them, rather than paying them, interest – again, though, because of worries that cash inflows into safe-haven Swiss francs would leave them with excess funds in their local currency that would be hard to deploy.
So what if the ECB, or even the Bank of England, were tempted to adopt such a policy? Would it really stimulate lending?
Given the other variables at work in Europe in recent years, it is impossible to pin down how Swedish lending volumes, for example, reacted to negative rates. But a glance at a typical lender, SEB, whose lending shrank 16 per cent between 2009, when rates went negative, and 2010, is hardly an endorsement. As Mr Draghi himself concedes, the root cause of low credit volumes is not necessarily poor supply but weak demand, with nervous consumers and cautious businesses avoiding unnecessary spending.
If the potential positives are hard to prove, the negatives of negative rates are not, which explains the growing nervousness among European bankers about the prospect.
First, there is the basic issue of practicability – officials worry that some banks may be operating with computer systems that simply could not cope with negative rates.
More fundamentally, negative rates would weaken the finances of banks across the eurozone at a time when investors are only now starting to feel reassured about their recovering health. Last week, investors took heart at further incremental progress in policy makers’ attempts to deal with the eurozone crisis, when finance ministers agreed to a key element of “banking union” – making the ECB the overarching supervisor of the region’s top 200 banks.
Negative interest rates would hit banks from several angles. Most obviously, it would hurt interest income by imposing a charge on central bank deposits. Despite the prevailing 0 per cent rate, there is still more than €200bn on deposit at the ECB.
More damagingly, though, it would shrink profit margins. Although banks can and do pass on rate cuts to depositors, there is a limit to how far banks can go into negative territory with their own branch deposit customers. Conversely, banks are routinely encouraged to cut lending rates promptly.
At a time when there is, quite rightly, continuing regulatory pressure on banks to increase capital levels, it would be perverse to introduce a policy measure that hurt profitability. In the absence of investor appetite for newly issued bank equity, retained earnings must be a core route to higher capital ratios. The only alternative would be further balance sheet shrinkage – less lending, in other words: precisely the outcome policy makers are supposedly keen to avoid.
The sting in the tail is that any hit to those crucial interest margins would be most acute in some of the most vulnerable parts of the eurozone. Both Italy and Spain traditionally source customer funds via products that guarantee rates for a year or two at a time, limiting their room for manoeuvre and intensifying the margin squeeze. The ECB should beware.
Patrick Jenkins is the Financial Times’ banking editor
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