On Thursday, December 3, the ECB will announce new measures to support inflation in the eurozone. A reduction in the deposit rate is eagerly anticipated, which some believe could also be accompanied by a reduction in the refi rate, the rate at which banks borrow from the ECB (see our previous insight on these two rates here). The refinancing rate is currently 0.05% and could fall into negative territory, as is currently the case in countries such as Sweden. This would mean that banks would now be paid to borrow from the ECB. Some see this as an aberration, which would lead banks to borrow much more than they need in order to take advantage of what appears to be a very good opportunity to make profits. Why is this not the case at all?
Under normal circumstances, a bank borrows during the ECB’s weekly refinancing operations to meet its own liquidity requirements. If we now assume that it borrows more liquidity than is necessary, we are assuming that the bank ends up with excess liquidity. With this liquidity, it has three main options: (1) leave it in its current account or in the ECB’s deposit facility (both options have yielded the same return since last year) ; (2) lend it to other banks ; or (3) purchase interest-bearing assets.
Option (1) will ultimately result in a loss for the bank, as the rate of return on excess reserves is lower than the rate at which it previously borrowed from the ECB (currently -0.20% for the former and +0.05% for the latter). It therefore makes no sense to borrow more in order to make a loss.
Option (2) is no more advantageous than in normal times with the negative rate. Indeed, if banks borrow at a lower rate than before, they will also, in practice, lend to each other at lower rates than before. This is the very mechanism by which monetary policy is transmitted. Whether the rate at which they initially borrow is negative or positive will not change their margin, i.e., the difference between the rate at which they borrow and the rate at which they lend. Option (2) therefore does not result in additional profits.
Option (3) appears advantageous at first glance. But here again, the ECB’s rate cut will also have led to a general decline in asset rates, through the same monetary policy transmission mechanism. Borrowing at a negative rate to purchase assets will therefore be as profitable as before (assuming that it was), since asset yields will have adjusted. Ultimately, nothing changes with the negative rate.
We can therefore see that a cut in the refi rate will not translate into a « very good opportunity to make profits » for banks. In the same way that negative borrowing rates for France do not translate into a « very good opportunity to make profits, » as we explained here following a segment on BFM TV.
Julien Pinter
See also:
The ECB’s negative interest rate: what are we talking about? (BSi economics)
Why do banks deposit their cash with the ECB’s deposit facility? (BSi economics)
Why doesn’t the French government take advantage of negative rates to issue a mega-loan and earn money through interest? (BSi economics)
