July 24, 2012 / 3:24 PM / 6 years ago

ECB mulls Danish-style deposit charge as lending prod

FRANKFURT (Reuters) - The European Central Bank may soon become the first of the world’s major central banks to try out negative interest rates on deposits in an attempt to force tight-fisted banks to lend.

Negative rates effectively mean that the ECB would charge banks to hold their money, something the central bankers hope will push them into lending and away from hoarding their cash.

The ECB is already some way towards this. It entered uncharted waters in July, cutting its main refinancing rate to a new record low of 0.75 percent and the rate it pays banks for overnight deposits to zero.

ECB policymakers Benoit Coeure and Klaas Knot have since hinted further cuts may follow if necessary, suggesting they are not afraid to experiment and go sub-zero with the deposit rate, prompting some economists to expect a cut as soon as September.

Such a move goes beyond what most central banks’ regularly do, so ECB is, for now, keeping a close eye on Denmark, which introduced negative bank deposit rates in July.

But although on paper the idea looks good, there are plenty of people who question whether it will work in a climate of extreme risk aversion.

Negative rates, or a charge, of 0.25 percent may not be enough to persuade banks to buy assets and lend to households, companies or other banks.

“Even with negative rates, it will not result in banks lending again to the periphery,” said Citigroup’s top euro zone economist Juergen Michels. “Negative rates will still be better than keeping cash in vaults.”

Most banks are not lending because they do not trust each other and that may not change even if they are penalized for it.

One euro zone central bank official put the threshold at which banks might start hoarding physical cash in their vaults at a deposit rate of negative 0.5 percent.

A recent survey of the ECB’s group of money market experts on risk management practices showed that 75 percent of respondents said a flat or even negative deposit rate would not change their usage of the ECB’s overnight facility.

Minutes of the group’s most recent regular meeting showed that there was also concern about the impact such a step would have on market activity or trade and on banks’ profitability.

Banks in euro zone core countries, such as Germany, the Netherlands, Belgium and Luxembourg - the heaviest users of the deposit facility - would have to pay the ECB about 2 billion euros per year on their excess reserves at negative 0.25 percent, J.P. Morgan said.


So enter Denmark.

The Danish central bank, whose policy aims to keep the Danish crown steady within a narrow band to the euro, cut its deposit rate to negative 0.20 percent in the wake of the ECB’s July rate cut to curb the strength in the Danish currency.

Sweden was the first central bank to go negative in recent history in 2009.

Denmark also has a limit in place on how much money banks can hold in the current account at the central bank.

Once the banking system as a whole has more than 69.7 billion Danish crown (9.4 billion euros) at the central bank, any additional cash is automatically swept into its negative interest rate facility.

The ECB may need a similar system.

“There are some technical issues the ECB would have to address first, whether or not they will put a ceiling on the amount that could be placed in the current account,” said Anders Lumholtz, euro zone economist at Danske Bank.

“That would at least be needed,” he added.

At the moment, the ECB pays interest at the main refinancing rate for the required reserves and nothing for excess funds.

When the ECB cut the deposit rate to zero in July, banks responded by shifting funds out of the ECB deposit facility and into their current accounts at the central bank.

RBS economists expect the ECB to signal plans for a negative deposit rate by changing the way it manages banks’ excess reserves, for example by starting to pay either zero or the deposit rate — whichever is lower — on excess reserves.

The ECB could do so at its August policy meeting, RBS added.

A negative ECB deposit rate, meanwhile, is likely to push the euro lower and it may also force the Danish central bank back into action.

“If the ECB cut the deposit to negative territory, our expectations would be that Denmark would follow once again and that Denmark would cut the deposit rate further,” said Danske Bank’s Lumholtz. “The Danish central bank has not hesitated so far and they would cut again if needed.”

Fearful of turmoil in the euro zone, investors have piled into non-euro zone assets, such as the Danish crown or Danish government bonds, and are willing to pay to shelter their money.

A negative deposit rate is likely to accelerate this trend and could also push the money market overnight rate into the red for the first time, which would mean that banks pay a certain rate to lend to other banks overnight.

“We will all gain some new experience,” said Citi’s Michels.

Reporting By Eva Kuehnen. Editing by Jeremy Gaunt.

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