Negative rates, a tiered system and the ECB

24 February, 2016

Lasse Holboell Nielsen, Research Analyst at Goldman Sachs, suggests that the prospect of further cuts in central bank policy resulting in rates going deeper into negative territory has had an adverse impact on investor confidence in banks.

Key Quotes

“We (and the market) do expect further policy rate cuts, notably n by the ECB in March.

An adverse investor response towards the impact of such policy easing on European banks may reduce the effectiveness of the rate cut in stimulating demand (and ultimately in achieving the ECB’s price stability objective).

While at this point we do not expect the ECB to introduce an expanded ‘two-tier’ system to remunerate excess reserves in March, such an approach is feasible – indeed likely – in the future, should further cuts be deemed necessary and as a way of reducing investor concerns about bank profitability. (Our current forecast does not envisage that such cuts will be necessary.) An indication in March that a tiered system is under consideration would signal that further rate cuts are possible (which would weigh on the currency) and reassure investors about bank earnings (easing pressures on market funding costs for banks).

We still view the limit on how negative rates can go as determined by the ‘cash arbitrage’ constraint (i.e., the incentive for banks to store physical banknotes at zero return rather than hold excess reserves at the central bank with a negative return). We have previously argued that this implies a constraint on rates closer to -0.50% than -5%. We maintain this view (although regulatory interventions to prevent financial institutions stockpiling banknotes would influence our assessment).

Bank profitability concerns, even if reduced by a tiered system, may mean the ECB is less willing to cut as deep as the cash arbitrage constraint may allow (which the Danish and Swiss cases show is at least -0.75%). At this stage, we see an ECB rate much lower than -0.75% as relatively unlikely.

Looking at the pass-through of past ECB cuts into negative territory, there has been a meaningful decline in household and non-financial corporate deposit rates at banks, particularly for term deposits. But retail bank deposits have nevertheless remained non-negative (and retail deposits likely remain more sensitive to negative rates while bank and large corporate deposits can more easily be affected by regulation and moral suasion from the authorities).

We see a case for further ECB cuts, within a tiered system, which allows for a steeping of the yield curve (for a given level of average interest rates), as a way to boost banks’ profitability, improve the availability of bank credit and stimulate economic growth.

We have less sympathy for the argument that negative rates per se reduce the incentive for banks to lend to the real economy. Rather, we see negative sentiment towards banks driven by non-fundamental factors (such as an excessive fear of negative rates) and a very flat yield curve (induced by asset purchases) as the key concern for bank profitability and the banking sector’s willingness to support the real economy in Europe.”


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