Europe’s controversial negative interest rates policy is not having the desired effect of stimulating growth, according to a report released this week by Standard & Poor’s.
Negative rates designed to encourage lending by punishing banks for holding cash and the ECB’s €1.7trn targeted long-term refinancing operations programmes have done have done little to boost economic activity, as European banks have chosen to use the cash to rebuild their balance sheets.
“They may have solid liquidity or funding but some are still building capital, which, when combined with weak credit demand, helps explain why we aren’t seeing greater investment in real economy assets,” said Giles Edwards, S&P Global’s senior director of financial services ratings.
Negative rates and a very shallow yield curve mean Europe’s banks are struggling with exceptionally narrow net interest margins and therefore huge challenges to profitability. S&P’s report says that the average return on equity of the 50 top rated European banks is a paltry 6%.
As European banks are reluctant to force negative rates on their depositors, there is a concern that risk profiles will be raised as banks chase income. “Although banks generally aren’t extending risk appetite right now as they feel they have other levers available, asset bubbles and risk appetite are definitely issues we’ve got our eye on,” Edwards said.
Rather than increase profits by increasing lending, banks are focusing on cutting costs, the report says. And while closing branches may seem counter-intuitive and could be difficult in less developed countries it is inevitable if banks want to transition to online services and ultimately lower expenses.
The good news is that loan impairment charges in 2016 are expected to be more than 40% less than in 2013 due to negative rates helping even struggling borrowers refinance debts.
The report seeks to evaluate the effect of the unprecedented negative rate environment on the global economy – and its conclusions are unsettling. “Moving to a negative rate environment, in every circumstance that we’ve looked at, is a clear sign of desperation with the list of potential economic damage from these policies substantial,” said John Kingston, director of global market insights at S&P and project director for the report.