ECB Rate Cut Has Instant Impact on Bank Lending

ECB Rate Cut Has Instant Impact on Bank Lending

12 Jul 2012 By: Reuters
The European Central Bank's new zero deposit rate had an instant impact as it came into force, with banks more than halving the amount of cash parked there overnight and one ECB policymaker saying he expected the move to increase banks' lending.
The unprecedented deposit rate cut to zero means banks will now get nothing if they park cash at the ECB , and the bank hopes it will nurture a return of more significant interbank lending by encouraging
banks to look for more profitable options.


Banks' reluctance to lend to each other for fear of not getting all their money back has prompted them to park money at the ECB. The sums they deposited there were boosted after the central bank unleashed over 1 trillion euros ($1.2 trillion) into the financial system with twin lending operations in December and February.

"Especially the fact that the deposit rate was reduced to zero provides an incentive for the banking system to look what alternatives there are to improve their earnings," ECB Governing Council member Josef Bonnici said on Thursday.

"This may lead to greater borrowing, especially in some member states," he told reporters o n the sidelines of a central bank conference in Casablanca.

An increase in bank lending could breathe life into the flagging euro zone economy, which the ECB said in its monthly bulletin was weak and suffering from "heightened uncertainty" that was weighing on confidence.

Wednesday was the first day under the new ECB zero deposit rate set-up. Figures published by the bank showed banks parked 325 billion euros overnight, well down on both the 800 billion they left there the previous day and the 700 billion they deposited at the same point of the last reserves period in June.

The latter comparison is probably the best. At the start of monthly reserves cycles banks have more options to juggle their funding so their deposits at the ECB tend to dip before building back up through the month.

The decision by the ECB to cut its main refinancing rate to 0.75 percent and stop paying interest on overnight deposits — before the cut banks got 0.25 percent — is also one factor driving the euro to this week's two-year lows against the dollar. That weakness will aid euro zone firms by making their goods cheaper for foreign buyers.

ECB President Mario Draghi has said he expects the zero rate to have little impact on what banks and other investors do with their spare cash.

Last month the ECB's money market contact group — a mix of around 20 top traders and a handful of top ECB experts — warned that the move could hurt interbank trading, push banks out of Europe and further damage their profitability.

Some top money market funds have closed their doors to new business since the cut, worried that they cannot provide returns for investors given the lack of a base return on funds held with the euro zone's central bank.

ECB policymaker Jozef Makuch told reporters on the sidelines of a conference in Vienna on Thursday the bank is not discussing narrowing the gaps between its main interest rate and the overnight deposit and lending rates which straddle it.

The ECB decided last week to cut its main refinancing rate by a 1/4 point to 0.75 percent as well as reducing its deposit rate by the same amount to zero.