ECB faces uncharted waters with negative rates

The European Central Bank would be moving into largely uncharted territory, with
potentially serious efects on the fnancial system and currency markets, if it goes
ahead with the increasingly popular idea of setting a negative rate on bank
deposits--essentially forcing banks to pay for the privilege of parking their money at
the ECB
ECB o!cials this week signaled the move is a top choice if they decide to take more
action to spur stronger euro-"one economic growth Earlier this week, the
#nternational $onetary %und said the &wiss 'ational Bank should consider a
negative deposit rate if the &wiss franc gets too strong (enmark)s central bank has
had a negative rate on certifcates of deposit for nearly two years and has *udged it
a success, though banks have had to absorb the added cost
#n the ECB)s case, the main goal would be to boost growth in two ways %irst, the
policy should encourage private-sector banks to loan more money to businesses
and households rather than holding on to it--at a loss--at the central bank &econd,
it could lower the value of the euro, which should help e+ports by making them
relatively cheaper on world markets
,nother potential beneft is that a weaker euro should drive in-ation up from
undesirably low levels, preventing a slide into de-ation--a dangerous fall in the
overall price level .igher in-ation would encourage more spending and make debts
easier to service
.ere)s how negative rates would work at the ECB/ 0hen banks have more money
than they need to make loans or meet minimum capital re1uirements, they can
park it overnight at the ECB, which has paid no interest since 2uly 3453 The bank
makes no proft on the deposit but doesn)t lose money #f the ECB sets a negative
interest rate, a bank would deposit a certain amount of money with the central bank
and get back that amount minus the penalty rate
#n theory, banks should prefer to loan the money to borrowers who would pay
interest Credit to the private sector in the euro "one has been shrinking from year-
ago levels in recent months %igures due Thursday are e+pected to show continued
contraction, which acts as a drag on economic growth
The idea has its doubters and its risks
&keptics warn that penali"ing banks won)t necessarily change their behavior They
say the decline in lending in Europe re-ects the lack of demand for new loans,
particularly in recession-ravaged parts of southern Europe
Critics say negative rates could weaken the already fragile European banking
industry by sapping its profts
6The banks that would sufer the most are those ones with lower proftability,6 said
,lberto 7allo, head of European credit research at 8oyal Bank of &cotland That
includes small banks in Cyprus and &lovenia, #talian banks and some 7erman
9andesbanken, or banks owned by 7erman states, he added
Banks also may pay less interest to savers and could raise the rates they charge on
private loans to recoup their costs
6%rom our point of view, it would be completely wrong to e+periment with negative
interest rates This would not lead to stronger lending and send a fatal signal to all
savers,6 7eorg %ahrenschon, president of the 7erman &avings Banks ,ssociation
(&7:, said in a recent speech
#f the banks don)t boost lending, why would they enter into money-losing
transactions with the ECB; They might calculate it is worth the cost to maintain
greater -e+ibility in managing their reserves
, negative deposit rate might have a more immediate efect on the euro, which is
above its long-term average against the <& dollar #t would make holding euro-
denominated assets less attractive for global investors, causing the currency to
weaken #t would also be a strong gesture from the ECB that it is willing to take
innovative measures to keep in-ation from falling too low
, weaker euro would help raise in-ation via higher prices for imported goods ECB
o!cials are wary because in-ation, at 4=>, is far below their target of *ust under
3> $arch fgures, due $onday, could show further weakening to 4?>, said
analysts at 2eferies #nternational
6The main lesson from the (anish e+perience @with negative ratesA is it has a huge
efect on the foreign-e+change market,6 said 2an &torup 'ielsen, analyst at 'ordea
in Copenhagen