Negative Interest Rates Breathing Room for European Banks

Financial institutions need at least a little relief from the ECB's negative interest rates, argues Michael Kemmer.
A euro sign is projected onto the ECB headquarters, lighting up the Frankfurt cityscape.

The European Central Bank (ECB) introduced negative interest rates at the beginning of June 2014 to fend off deflation and boost the European economy. Since then, these goals have largely been achieved, though there appears to be little willingness to put an end to this exceptional monetary policy.

Because the ECB's negative interest rates can hardly be passed on to customers, on a broader scale they act as a special tax for commercial banks in the euro area.

Commercial banks are currently paying half a billion euros a month, or more than €6 billion a year, as a "liquidity tax" on the more than €1.5 trillion ($1.64 trillion) in liquidity that has accumulated as a result of the ECB's bond-buying program. The amount will only grow now that the bond-buying program is being continued until the end of the year.

It would make sense to exempt at least a portion of the banks' excess liquidity from the ECB's negative interest rates. Michael Kemmer, Managing Director of the Association of German Banks

This special tax deprives European banks of money they need for urgent programs, including restructuring, expanding digitization and strengthening their capital base. The burden imposed on the banking sector by negative deposit rates is one of the many adverse side effects of the ECB's extremely expansive monetary policy – one  the Association of German Banks has been warning about for a long time.

In order to partially limit the collateral damage of this negative interest, it would make sense to exempt at least a portion of the banks' excess liquidity. Both Switzerland and Japan have been using this measure for some time.

For instance, the Swiss National Bank grants the country's commercial banks an exemption from negative interest rates corresponding to 20 times the minimum reserve target, but at least 10 million Swiss francs ($10 million) for each commercial bank. If applied to the banks in the euro system, 20 times the minimum reserve target would currently amount to more than €2 trillion.

The argument that an exemption would encourage banks to reduce lending and keep more excess liquidity on deposit with the ECB is implausible. At the moment, credit development in the monetary union is mainly restricted by demand and the poor solvency of some borrowers. Even without negative interest rates, most banks in the euro area would jump at the chance to lend more money.

A more favorable outlook for the profitability of banks and a strengthening of balance sheets could sustainably strengthen credit conditions. In any case, the limitation or abolition of the special tax by means of negative interest would be a positive contribution to financial stability. Indeed, it's already long overdue.

The author is the managing director of the Association of German Banks. You can reach him at: [email protected]