ECB open to unusual stimulus planEuropean Central Bank President Mario Draghi surprised markets and analysts last week by saying the central bank is open to an unconventional stimulus tactic: pressuring banks to lend by charging them a fee for parking cash at the ECB.
The development does more to highlight the limits of the ECB’s powers than to demonstrate its boldness in dealing with the euro area’s economic slump.
The euro immediately slumped against the U.S. dollar after Draghi’s statement. This might have been his aim: A weaker currency can help euro-area countries trying to export their way out of the crisis. But it is also possible that Draghi was doing something unusual for a central banker: being candid about the tools under consideration for unblocking the flow of credit in the region.
Most of the euro area’s businesses are small- and medium-sized enterprises, responsible for about 60 percent of gross value added and from 60 percent to 80 percent of employment in the European Union in 2012. In the few years leading up to the global financial crisis in 2008, borrowing costs for such businesses rose and fell roughly in line with the ECB’s short-term target interest rate and differed only slightly from one country to the next.
More recently, the ECB’s control over credit has weakened in peripheral euro-area countries such as Spain and Italy. In these countries, borrowing costs for small- and medium-sized businesses, which are entirely dependent on banks for funding, have risen significantly over the past few years even as the policy rate has dropped. Meanwhile, bank lending has contracted throughout the euro area as financial institutions deleverage and shy away from risk.
In its efforts to get banks lending again, the ECB is looking at excess reserves - some 120 billion euros ($157 billion) the banks have been holding on deposit at the central bank for safekeeping. If the ECB were to introduce a negative interest rate on deposits, effectively charging a fee, the banks might choose to lend the money out rather than watch it lose value.
This logic is far from ironclad. Instead of lending the money to businesses and individuals, the banks could simply park it elsewhere - for example, in the sovereign bonds of Germany and other countries perceived to be financially healthy. This might benefit Germany by further pushing down its borrowing costs, but would do little to unblock credit to businesses. Banks might even try to cover their losses on the ECB deposits by charging higher interest rates on business loans, precisely the opposite of the desired outcome.
Even if negative deposit rates did spur more business lending, that’s not necessarily good. If it prompts banks to make risky investments at a time when most of them already have a number of bad loans on their books, it could damage their balance sheets further.
There are better ways for the ECB to encourage banks to lend. Banks might make more business loans, for example, if the ECB made it easier to use those loans as collateral for cheap central-bank credit. The ECB could do so by loosening requirements for the amount and type of business loans that it accepts in exchange for liquidity, and by lending more against a given value of loans.
The central bank could go a step further and agree to purchase business loans in the secondary markets. Banks would be more willing to accept the risk of lending to small and medium-sized enterprises if they knew they could turn around and sell those loans to the ECB. For now, the ECB is unwilling to accept this degree of risk on its own balance sheet. That could change as the recession in the euro area deepens further.
Even if the ECB could encourage banks to lend, though, that doesn’t mean businesses will borrow. The primary issue in the euro area isn’t the cost of funding. The main problem is that few businesses want to borrow at any cost. According to a recent ECB study on access to financing in the euro area, “finding customers” is the No. 1 concern for businesses in the region. If businesses are worried about demand, they will not seek loans to grow.
Reviving consumer demand and business confidence in the euro area falls beyond the ECB’s remit. That’s up to government policy makers, and would probably require real progress toward establishing an effective banking, political and fiscal union. Unfortunately, market calm has inspired complacency, and there currently seems to be little political will to take the steps necessary to achieve a more viable union.
The ECB is, without a doubt, the most powerful institution in the euro area. But it can’t fix bank lending and stimulate growth on its own.
*The author is a Bloomberg View columnist and chief economist at Maverick Intelligence.
by Megan Greene