As the governing council at the European Central Bank (ECB) is set to convene this week, possibly to discuss a fresh round of economic stimulus package, one of the main issues set to be discussed revolves around the impact left by policy tools on the banking industry, and the market at large.

Policy makers will be focusing on whether the already-introduced and prospective measures will result in more harm, rather than the market reaping the benefits. 

A possible rate cut, which is undoubtedly on the cards, may leave a negative impact on the stressed European banking institutions, on one hand discouraging further lending to businesses and households, and depositors seeking other sources to create capital appreciation, other than that provided by banking institutions on the other. 

Consequent to an interest rate cut, a continued shift towards the hoarding of physical cash may be envisaged, albeit the market is well aware that any rate cut by the ECB would ‘hopefully’ serve to propel economic growth and stimulate investment, which is rather contrasting.

Deutsche Bank’s chief issues a warning 

In relation to the expected interest rate cut, set to be discussed by governing council at the ECB, Christian Sewing, Deutsche bank’s chief executive, in a banking conference taking place in Frankfurt, argued that an interest rate cut would hardly stimulate the economy. For instance, medium-sized businesses may not necessarily invest more, just because financing will now be a few basis points cheaper.

Sewing also stated that despite the fact that interest rates hovering below zero levels may result in cheaper financing for governments, it may leave some “serious side-effects”, adding that “few economists, at least, believe that cheaper money on this level [interest rate level] will do anything”.

Impact on banking institutions 

With the profitability of banking institutions being heavily reliant on interest rate levels, a further interest rate cut, implemented to stimulate economic growth, would by no means be welcomed with open arms by all market players. A policy rate cut would result in squeezing the profit margins of banking institutions, predominantly of institutions reliant on customer deposits, this adding-on to the mounting pressure banking institutions have been experiencing since the recent global financial crisis. 

ECB considering the damage being done by negative policy rates 
Realising that a further interest rate cut may seriously damage the profitability of banking institutions, the Governing Council at the European Central Bank is set to consider whether to mitigate the impact on banks. Should the Governing Council decide to mitigate the impact on banking institutions, there are two possible options; 

Firstly, the ECB may introduce a tiering system that excludes a portion of excess deposits from negative rates, this being already set-in-stone by countries with negative deposit rates such as Switzerland, Denmark, and Japan. Secondly, the ECB may resort to subsidised lending.

Another tool at the ECB’s disposal is inevitably a fresh wave of asset purchases. With the previous rounds of asset purchases not having as much as lasting effect on the Eurozone economy as the ECB would have wished for, investment grade corporate bonds as opposed to the previously purchased Eurozone government bonds, could well form part of the ECB’s new Corporate Sector Purchase Programme (CSPP), as the ECB’s balance sheet is already laden with Eurozone government bonds.

This article was issued by Christopher Cutajar, Credit Analyst at Calamatta Cuschieri. For more information visit, https://cc.com.mt/ . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.