ECB View: Deposit rate tiering is more complex than it seems – The ECB has repeatedly stated that it will ‘continue to monitor carefully the bank-based transmission channel of monetary policy and the case for mitigating measures’. This against the background of concerns that (more deeply) negative interest rates could have an adverse impact on the banking sector, which could lead banks to eventually tighten financial conditions. So is the bank transmission mechanism being effected by negative rates? What kind of mitigating effects can the ECB take? To start with the first question, the evidence up until now of an adverse effect on the bank transmission mechanism is not very convincing. The release earlier today of the central bank’s own bank lending survey showing tightening lending standards for banks (see below) but this seemed to mainly reflect concerns about the economic outlook rather than the impact of negative rates. In addition, it follows a prolonged period of easing during the negative rate period.
The main mitigating measure often discussed by commentators is deposit rate tiering. This involves making a significant proportion of the excess reserves held in the ECB’s deposit facility cost free (rather than at the deposit rate of -0.4% currently). However, the benefits of this system are moderate and it would be difficult to design. A tiering system could reduce direct costs to banks from negative interest rates by around EUR 6.5bn. Further rate cuts and additional QE could perhaps double the cost (and hence the benefit) but it would still be relatively modest compared to bank earnings. A bigger potential issue with negative rates is the squeeze in interest rate margins. Meanwhile, a Swiss-style tiering system – where all banks are allowed a cost exemption on the same proportion of reserves – could have externalities. In particular it would encourage banks in a number of countries to move aggressively out of government and covered bonds and into cash. Avoiding the issue would involve an inequitable excess reserve allowance from one bank to another (see link to our note below).
Other measures could be more desirable. Importantly, making the cost and maturity of the TLTRO programme more generous than announced up until now could be a good way to go. Meanwhile, we think that there are positive effects for banks when considering the ECB’s easing package as a whole. For instance, net asset purchases will lead to lower funding costs because of the compression of bank credit and covered bond spreads. In addition, to the extent that monetary stimulus over time supports economic growth, this would tend to lower provisions for banks and increase loan growth. (Nick Kounis & Tom Kinmonth)
Euro Macro: Banks tighten lending standards on loans to companies – The ECB’s Bank Lending Survey (BLS) for Q2 showed that banks, on balance, tightened lending standards on loans to companies. The net percentage of banks that tightened standards rose to 5, up from -1 (net easing) in Q1. This tightening was in conflict with the forward looking part of the survey of the quarter before, when banks had expected to ease standards in Q2. The forward looking part of the Q2 survey shows that banks expect to keep standards unchanged in Q3. The main reason for the shift in credit standards in Q2 was a deterioration in banks’ risk perceptions related to the general economic and firm-specific situation. On top of that, the same as in Q1, banks’ risk tolerance and cost of funds contributed to the tightening of standards, whereas competition from other banks on balance had an easing impact. Besides the tightening of lending standards, banks rejected a larger share of loans, with the balance rising from 2 in Q1 to 7 in Q2, which is the highest since the start of this part of the BLS in 2015. Meanwhile, banks reported that demand for loans by companies increased in Q2, with the balance of higher and lower demand rising from 0 to 6. The level of interest rates and fixed investment continued to have a positive impact on loan demand, although more moderately than in Q1. In contrast, loan demand stemming from inventories and working capital declined for the first time since 2013. Overall, the results of the BLS are signalling that bank lending to companies is slowing down. Indeed, the annual growth rate of loans to companies has been moderating since the middle of 2018 and we expect it to decline more noticeably in the coming quarters. (Aline Schuiling)