ECB’s negative rates hammer savers but will it make banks lend?

July 16, 2014Bankingby QFinance

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What we have seen post the 2008 global financial crash, as the US Federal Reserve, the Bank of Japan, the Bank of England and the ECB have sought to pump money into their respective real economies in order to get growth going again, is an absolutely enormous transfer of wealth from savers to borrowers. Whether you are getting 0.2% nominal interest on your savings on deposit with a bank, or whether your bank decides to hit you with, say, a 0.1% “holding fee”, might be psychologically significant, but in reality the imposition of such a charge simply reinforces the idea that holding cash in a bank account is not a good idea right now, and hasn’t been since, oh, say 2008. This is not a terrible thing, since there are a huge number of alternatives to holding cash in a bank account.

Exploring the options here could take several (or even several dozen) blogs and is not my topic this go round, so I will pass over it lightly, except to point out that most of these alternatives involve assuming at least some level of risk. But since holding cash at negative rates, with the negative being amplified by whatever level of inflation might be around, is certain to generate a modest level of loss anyway (we are not yet, after all, in official deflation territory) there simply are not any risk-free alternatives around anymore. It may be, therefore, that the negative deposit rate fiasco, if it comes about, could have the positive effect of goading the general public into the realization that the time has come for them to get off their behinds and “wise-up” on investing. (I have a future? I need to invest? What is this...?)

For more than a decade, successive UK governments have been trying to get the public to realize that no government in any market with a declining ratio of workers to pensioners, can, over the medium term, afford the welfare and pensions promises its politicians have been making to voters in order to boost their own electoral chances. The logical corollary of finding out that the state simply will not be in a position to take care of you in your old age, is that you have to assume that responsibility for yourself – which means finding ways of generating a sufficient pot of money while you are able to work, to keep you in relative comfort when you can no longer work. It’s that simple. In this respect, negative rates for depositors, if they come, should simply stimulate an active financial services sector into offering more lucrative and relatively low risk alternatives to bank deposits. Negative rates should also prompt financially illiterate savers into becoming a tad more literate. “My bank is robbing me, what are my options?” is, after all, a fairly basic question.

It is also worth asking where negative deposit rates would leave the banks, given that banks were supposed to need to attract cash from depositors, aka savers, in order to lend? ECB banks also need new cash not to lend but to repay bond holders on maturing bonds. Their options here are to refinance by issuing new bonds, attract more depositors or borrow from the ECB.  Actually, of course, in the Brave New World crafted by that Italian master craftsman, Mario Draghi, president of the ECB, the EU’s established banks do not actually need to bother themselves with attracting new depositors or new investors. They can simply go direct to the ECB under its Long Term Refinancing Operation (LTRO) and borrow at ultra low rates and then lend out at commercial rates, if they so choose. (For a more detailed account of the workings of LTRO see this blog by Zero Hedge.)

This in itself begs the question of just how rubbish a bank’s credit committee has to be in order for it to lose money on commercial and private lending when it has the freedom to borrow low and lend high. This go round, Draghi has added the proviso that the ECB’s LTRO loans will only be available for lending to non financial institutions and will not be available for private mortgage lending, hence the new LTROs are being called Targeted LTROs, or TLTROs. The loans will only mature in September 2018 and will be worth some 400 billion euros in total. Oh, and one more thing, up until now, the ECB has “sterilized” all loans made under the LTRO by selling an equivalent amount of assets off its books. Draghi mentioned in passing that henceforth the ECB is suspending this sterilization. So Draghi and the ECB are now planning to pump 400 billion euros of new money into the EU economy, with further TLTRO tranches to follow. In effect the ECB has begun quantitative easing (QE), something its mandate is supposed to preclude it from doing. As I said, Draghi is a master craftsman...