November 30, 2014 / 8:33 AM / 4 years ago

Negative ECB deposit rate may pose problem for QE if/when it comes

LONDON (Reuters) - If the European Central Bank decides to start buying sovereign debt to stave off euro zone deflation, it may first have to tackle disincentives that analysts say could make banks unwilling to sell.

A placard featuring an Euro bank note is seen outside the money museum next to the headquarters of Germany's federal bank Deutsche Bundesbank in Frankfurt February 4, 2013. REUTERS/Kai Pfaffenbach

Banks are among the largest holders of euro zone debt and so would be the main market for the ECB should it decide to buy bonds in a fully fledged quantitative easing, or QE, programme.

But they may be reluctant to sell unless the ECB tweaks its current interest rates or allows banks to hold more bonds in reserve with the central bank.

“We believe that to buy large quantities of government bonds from banks it is necessary to give the banks something in return,” said Steven Major, global head of fixed income research at HSBC.

Faced with tepid growth and near-zero inflation, the ECB might decide as early as next quarter to begin buying sovereign bonds.

Others have done this, including the U.S. Federal Reserve, Bank of Japan and Bank of England, but the ECB would be the first major central bank to launch QE while also having a negative deposit rate.

That is effectively a tax on cash that financial institutions hold in an ECB debit account. HSBC says it may become a major stumbling block to banks selling their bond holdings.

Citing data from major central banks that have previously embarked on QE, HSBC says most of the money banks get from selling their assets ends up back with the central bank.

In theory, the ECB’s negative rate should break this cycle, providing an incentive for banks to use spare cash to lend to the economy. But HSBC argues it could scupper the scheme because banks will simply refuse to sell bonds.

Banks are encouraged to hold euro zone government bonds for regulatory purposes and as trading inventory to service clients. ECB data shows euro zone banks hold roughly a third of the 6.6 trillion euros of sovereign debt outstanding.

If banks chose to hold on to their bonds, the ECB would have to buy directly from asset managers, pension and insurance funds, many of which need the assets to match liabilities.

OTHER OPTIONS

Some are not persuaded that incentivising banks can only be achieved by raising the deposit rate.

Francesco Papadia, the former head of money market operations at the ECB, said banks were primarily concerned by the all-in cost of borrowing and then depositing money. The ECB has long maintained a so-called “corridor” between the two rates.

If banks prove resistant to the ECB’s initial advances, Papadia said it could tighten this margin by lowering its benchmark borrowing rate, currently at 0.05 percent, rather than raising its -0.20 percent deposit rate.

“The ECB is trying to ease monetary policy and this would be contradicted by raising the deposit rate after having insisted that the negative deposit rate was a significant easing,” Papadia said.

There is another solution that avoids tampering with interest rates all together, said Nordea’s chief fixed income analyst Jan von Gerich.

While doubting that the ECB will reduce penalties on banks at the outset of any QE programme, he said it could raise limits on banks’ excess reserves if they will not budge.

Separate from the deposits, banks must hold a set amount of reserves at the ECB, on which interest is paid.

“It would be an easier decision for them to change the limits on the excess reserves than change the deposit rate,” said von Gerich.

Editing by Jeremy Gaunt

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