Just how deep can negative interest rates go? Well, you do not have to wait for long to find the answer of this question because the European Central Bank (ECB) is going to occupy the stage on Thursday and this particular question will be answered.

The Mandate

Market participants are widely expecting the ECB to rotate the interest rate screws again and financial institutions are going to feel the pain because of deeper negative interest rates. The ECB’s mandate is to spur growth and inflation in the eurozone and in order to do this, they are committed to do “whatever it takes”, a slogan which the president of the European Central Bank used, to achieve this.

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The blow for this tactic has the largest adverse impact for banks such as Deutsche Bank AG, UBS Group AG and many other. These banks have been battling with sub-zero monetary policy for almost half a decade now and a further squeeze is going to hamper their bottom line figures. Remember, banks provide liquidity into the system for households and companies and pushing the bar too far may break it altogether. Long term negative interest rates can not only drain banks but also it can collapse the financial system.

However, the ECB isn’t willing to pay much attention to these factors as they have much bigger problems on the doorstep such as U.S. protectionism and the Brexit circus. The bank starts its two-day monetary policy meeting today and concludes it tomorrow and the probabilities of a softer blow aren’t favorable

How Much Have The Banks Paid?

Banks used to park their excessive capital with the ECB to earn interest, however, that interest rate currently stands at -0.4%, which means banks like Deutsche have to pay to park their cash with the ECB. This sub-zero interest rate results in billions of euros for banks. Since 2014, when the ECB started the negative interest rates, banks have paid nearly 23 billion euros. The current cost for banks stands at nearly 7 billion euros a year.

Banks have digested these cost by passing this on to their corporate clients, but retail clients who have saved this money by working hard are going to be left with no option but to withdraw this cash. This is going to create a much deeper liquidity strap for the ECB as these deposits is the main source of financing for banks.

What Is The ECB View About These Charges

The European Central bank is confident about their approach and the bank believes that the current cost for banks is like peanuts. Their focus, for the time being, is only to promote long term growth and stability.

What Is The Reversal Point, Are We There Yet?

The European Central Bank does know that it cannot just keep pushing the interest rates lower and lower. The point where the bank thinks that it has reached its maximum limit is the reversal point. The former vice president of the bank has mentioned that he thinks that the ECB has reached that point. However, the president of the ECB, Mario Draghi, only acknowledges the risk associated with negative rates. He doesn’t think that we have reached the bottom yet. This leads me to believe that the ECB is going to continue to push this bar for now.

So, What is the solution for this?

Well, a tiering system is something which has been discussed before, Basically, a system under which retail investors do not pay the negative interest rate for their deposit, and this way, they are incentivized to keep their capital at banks. Draghi has said previously that it tiering system has been discussed before, but it is still up for discussion if such exemptions should be allowed. For the record, the Swiss National Bank, SNB has been using this system for a while in order to soften the blow. The SNB earned nearly 2 billion francs from banks with its -0.75% which was a lot higher than it earned back in 2014 (only a few hundred million). Clearly, this profit for the SNB has come at the cost of others such as UBS and Credit Suisse.

The Best Approach For Now

The ECB doesn’t have the ultimate power, if any, to dictate the fiscal policies of the eurozone countries. The fact is that negative bond yields for German and Euro bonds are here because investors do not believe that the ECB can do much with its monetary policy. Countries like Germany have been reluctant to do fiscal spending, but the pressure is on.

Negative rates and anti-globalization policies are far more dangerous than anything else and I believe this is going to force the governments to do fiscal spending.


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