October 3, 2016 / 5:01 PM / a year ago

UPDATE 1-ECB's Mersch warns further rate cuts could backfire

* Warns of effects of further cuts on banks (Adds detail; changes dateline (previous: Frankfurt)

By Michele Sinner

LUXEMBOURG, Oct 3 (Reuters) - Charging banks even more to park their money with the European Central Bank could backfire if the damage to the banking sector outweighs the benefit for borrowers, ECB Executive Board member Yves Mersch said on Monday.

As part of its efforts to stimulate lending, the ECB has been applying a penalty charge - or negative deposit rate - on banks' excess deposits for over two years, triggering a backlash from cash-rich banks especially in Germany.

Mersch defended the ECB's policy, saying it has helped bring down unemployment and boost growth in the euro zone, but acknowledged the banking sector would come under pressure if rates were cut further.

"There is a limit to how low interest rates can go -- the point at which the costs of lower rates incurred by the banking sector outweigh the benefits," Yves Mersch said.

"Cutting interest rates even more would come with increasing risks, as reactions to such cuts might not always be linear," he added.

Banking shares have sold off sharply in recent weeks as worries about the impact of low interest rates on their profits were compounded by the threat of a multi-billion-dollar fine hovering over Germany's largest lender, Deutsche Bank .

Mersch said that the ECB was cognisant of banks' woes, but argued that lenders that cannot withstand a few difficult years might not deserve to stay in business.

"One also has to ask if a bank that cannot weather headwinds over a few years still has a sufficiently robust business model to stay in the market," he said. (Writing by Francesco Canepa in Frankfurt; Editing by Catherine Evans and Toby Chopra)

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