From Reuters: UPDATE 3-Negative euro overnight rates show cracks in banking system
While there are many signs of cracks in the Eurozone, European banks “paying” negative rates to other banks for lending money is not one of those. It is simply the profit-maximizing consequence of the ECB’s decision to charge banks for any reserves above the required minimum.
What happens is the following:
Bank A (short of liquidity) must settle a payment with Bank B for one million euros. This means Bank A must send one million to Bank B. If Bank B believes they have enough liquidity already, they will carefully consider the consequence of being credited one million and being charged a negative annual 0,10% by the ECB.
A better alternative for Bank B is to ask Bank A not to send the amount due, and be paid a fraction of (up to) 0.10% for borrowing it.
See the Q&A on negative rates.
A response to Steve Hanke’s defense of austerity
Since the outcome of the European elections, political leaders in the EU’s most stagnating countries have been calling for an end to austerity. While they seem unable to develop a realistic and politically palatable alternative, Europe remains in the doldrums, and pro-austerity views are having a comeback. One such example is Professor Steve Hanke’s defense of austerity (in “The EU’s Anti-Austerity Hypocrites” which aims at reasonable objectives with the wrong tools.
Today, on Social Europe Journal, why Europe’s policies still head in the wrong direction.
The move of the ECB on June 5 was primarily aimed at restoring conditions of low and stable money market rates.
It was not difficult to predict (as I did here six weeks ago) the direct consequences of the new official rates and, notably, of the prolongation of fixed rate, full allotment tender procedures, and of the decision to suspend the weekly fine-tuning operation sterilising the liquidity injected under the Securities Markets Programme.
Except for the end-of-June spike, money market rates appear more stable and lower.
Mario Draghi’s “historical measures” (as defined by Bloomberg) are best seen as ways to restore the interbank rate of interest (EONIA) that prevailed throughout 2013, when the interest rate that banks paid each other for lending and borrowing liquidity (aka “reserves”) had stabilized a few basis points above zero.
This rate is the main policy-driven rate that shapes all money market rates. A super-low and stable EONIA had been the outcome of two ECB measures in 2012: the VLTROs and the Deposit Facility rate cut to zero.
As of 11 June 2014, the interest rate on the Eurosystem Deposit Facility is -0.10%. This negative rate applies to all banks’ holdings of euros in excess of the minimum reserve requirements, as well as to cash balances above a certain threshold that Eurozone governments hold in the Eurosystem (this is cash obtained through taxes or bonds issued and not yet spent), as well as to all deposits held by non-Eurosystem central banks.
What does it mean that the ECB sets a negative interest rate?
In the same way as an interest paid by the ECB to holders of euros is a net addition to holders’ income, an interest paid by the banks to the ECB for holding euros is equivalent to a tax on holders of euros.
Has the ECB lowered interest rates at historical low?
Not exactly. The rate goal of the ECB is the interbank rate (called EONIA). This has always been below 0,10% in 2013. The problem was that as banks began early repaying their LTROs, EONIA went above 0,10% in 2014. Thus, today’s move is simply an attempt to pull EONIA down to below 0,10% and stabilize it there, if possible.
Is the negative rate on the Deposit Facility big news?
Given that the ECB will apply, as of June 11, a negative rate on ALL excess reserves (Deposit facility AND Reserve account), and given that the ECB is expanding excess reserves by ending SMP sterilization, my early considerations on the effects of negative rates apply.
Awaiting tomorrow’s ECB decision, it’s worth restating the main issue the ECB is facing.
Not much has changed since April: The ECB is still having trouble controlling interest rates.
Mario Draghi says ECB is open to asset purchase to battle low inflation
The current concern of the ECB these days is illustrated below: The ECB is having a hard time controlling interest rates!
The upward trend and volatility of the interbank rate reveals a failure to control the market interest rate using policy rates.