ECB View: Draghi opens the door to tiered rate, but not imminent – ECB President Mario Draghi gave a clear signal that the central bank was open to considering ways to alleviate any adverse effects of negative rates on the banking system going forward. In a speech today at the ‘The ECB and Its Watchers’ conference in Frankfurt he asserted that ‘we will continue monitoring how banks can maintain healthy earning conditions while net interest margins are compressed. And, if necessary, we need to reflect on possible measures that can preserve the favourable implications of negative rates for the economy, while mitigating the side effects, if any’. Later in the day, Reuters reported ECB sources saying the central bank was studying ‘options to lower the charge that banks pay on some of their excess cash as a possible way to offset the side-effects’. Though it also noted that no proposal had been made and that the work was still at the staff level. So will the ECB act imminently, and if so, what would it do?
We do not see action coming imminently. This is because the hard data suggest that the adverse impact on the bank lending channel emanating from negative rates is limited. Indeed, on balance we would say that the effects are still positive. During the period of negative rates, bank lending rates have fallen, bank lending has expanded and lending standards have eased. On the surface therefore, there is little evidence that negative interest rates have hampered the transmission mechanism. Bank profits have risen during the period of negative interest rates. Net interest margins have remained rather resilient in the face of negative rates, while provisions have decreased to historical lows (see our recent note ‘ECB Watch – Time to go back to zero?’ for more on this). The resilience of net interest rate margins reflects that wholesale funding costs have come down, while the impact of lower bank lending rates on interest income may take some time to fully come through given that a significant proportion of outstanding debt is long-maturity and at fixed rates. So the adverse impact may come through in time, but we are not there yet.
If the ECB were to see such an adverse impact, it essentially has two policy options. First, it could move to a tiered deposit rate system, a policy that is in operation in Japan and Switzerland for example. Currently, the ECB charges its deposit rate (-0.4%) on all excess liquidity. However, it can still anchor market interest rates (starting with EONIA) at the deposit rate even by charging only a proportion of excess liquidity at the deposit rate, and the rest at the refinancing rate. This is because the level of excess liquidity is much higher than the level necessary to anchor the overnight interbank rate to the deposit rate. The current level of excess liquidity is around EUR 1850bn, but likely only around EUR 200bn are need to anchor interbank rates. So the ECB could charge the deposit rate only on that amount of excess reserves, which would reduce the cost to the banking system by around EUR 6.5bn per annum.
The second alternative, would be to subsidise banks via an even more negative on TLTROs or other lending facilities. For instance, the lending rate on TLTROs could be more negative than that on the deposit rate facility. The objection here would be that banks could conduct a ‘carry trade’ inside the Eurosystem by borrowing for the TLTRO scheme and then placing it in the deposit facility. So we think this would the least likely of the two measures, and would be a step the ECB would take in a more extreme macro scenario. (Nick Kounis)