Negative interest rates impacting like a special tax in the euro zone

The low profitability of European banks has long been a problem, and the ECB in its role as banking supervisor regularly addresses this issue. While the institutions affiliated with the US Federal Deposit Insurance Corporation (FDIC) managed to generate a return on equity (ROE) of 11.8% in the fourth quarter of 2018, the 190 European banks chalked up average ROE of just 6.5%. In addition to other structural issues and business policy decisions, the ECB as monetary policy maker is also a reason for the low profitability.

Banks in the USA are benefiting from the fact that their deposits, most of which are still interest free, have appreciated in value thanks to interest rate hikes, while European banks are actually having to pay an interest rate of currently 0.40% per annum on their surplus reserves at the ECB due to the deposit rate being negative. Based on current credit balances, this corresponds to annual interest expenses to the tune of EUR 7.6 billion. According to our estimates, German banks can expect to incur interest expenses of EUR 2.4 billion and French banks of EUR 2.0 billion, while Italian banks with their lower ECB deposits, for example, can expect to pay only EUR 343 million a year.

The negative interest rates are therefore impacting like a special tax on banks. The ECB could remedy this situation relatively easily by raising the deposit rate to 0. But there is little likelihood of this happening. Over a medium term horizon, the weakening economy and falling inflation rates argue more for a further ease in monetary policy. It therefore comes as no surprise to learn that the ECB has now started discussing the possibility of partially exempting ECB deposits from the negative deposit rate. An instrument of this kind would lower the burden of negative interest rates on the European banking system and even create openings for reducing interest rates even further. If, however, the ECB decides against the introduction of a graduated system of this kind for banks’ ECB deposits, another alternative might be to slightly raise the deposit rate to minus 0.25%. Whatever: the profitability problems of European banks will not be solved by such measures.

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