ECB Doing Whatever It Takes Can't Make Euro-Area Banks Lend

Why European Banks Aren’t Lending
  • Charging interest on deposits at central bank hasn't worked
  • Bad loans, weak capital, restructuring have kept lending flat

The European Central Bank began charging banks interest on deposits in June 2014 to encourage them to lend more to companies and consumers. It hasn’t worked.

QuickTake Negative Interest Rates

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.”

A spokesman for the ECB declined to comment on the impact of policies on bank behavior.

Lending Levels

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 the new ECB measures will provide banks with stable funding, that might not be enough to boost lending because demand for loans is lacking, said Axel Weber, a former head of the German central bank. Weber, now chairman of UBS Group AG, also blamed stricter regulations for making it harder for banks to increase lending.

“What I see much more important is the long-term funding security it gives banks rather than the marginal changes in the conditions for lending,” Weber said Monday on Bloomberg Television. “At the banks, we’re more focused on deleveraging rather than putting on new exposures. The two measures that come in might help to soften and provide a more orderly deleveraging, but it will not break the trend.”

‘Poor Performance’

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. Banks already are charging interest to some institutional clients and might do the same for small savers, he said.

“Some money will go to cash under the mattress, but not most,” Carbo-Valverde said. “Especially if inflation is negative, then you’re not really losing money when your savings has a negative rate as well.”

The ECB’s biggest concern has been negative inflation, or deflation. Inflation in the euro area has fluctuated between -0.6 percent and 0.4 percent in the past 18 months.

Cross-Border Loans

The lack of a unified financial system like the one in the U.S. has been a drag on Europe’s economy, according to Carbo-Valverde. Since 2010, European banks have reduced cross-border lending, resulting in higher borrowing rates for companies and consumers in some countries. That’s because one nation’s extra savings don’t get channeled to places that need more funds.

More than 80 percent of deposits at the ECB come from German, French, Dutch and Finnish banks. Northern European lenders prefer to park their cash at the central bank, even though they’re paying to do so, rather than lend to Italian, Spanish or Portuguese banks. That’s because national regulators have discouraged cross-border lending and the firms are afraid of further blow-ups in southern countries. Banks there rely on the ECB to cover funding shortfalls.

Banks in countries with savings gluts will pay about 2.6 billion euros to the ECB in the next 12 months to keep their extra cash there, according to data compiled by Bloomberg. That figure could rise if the deposit rate gets more negative or if deposit balances rise.

Italian banks would have trouble increasing their lending even if more money flowed in from other countries or ECB coffers because they’re saddled with bad loans reaching almost 20 percent. Spanish and Irish banks, which cleaned up their balance sheets through government bailouts, can’t expand lending because there’s little demand from customers still too indebted to borrow more.

European banks need more capital to clean up their balance sheets and increase lending, but low stock valuations make it tougher to raise equity, said Carbo-Valverde.

“The story is about recapitalization, not more liquidity,” he said. “Banks can’t respond to the ECB’s attempts to boost lending unless they’re better capitalized. So I don’t think the new measures will work. It’s like applying more of the same drugs to a patient who hasn’t been responding to those drugs so far.”

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