In 2014, the European Central Bank [ECB] did the unthinkable and cut the Eurozone deposit rate to below zero [minus 0.25%]. In 2016 it reduced the rate further to minus 0.4%. The Eurozone deposit rate is what commercial banks pay to keep their money on deposit with the ECB. These actions formed part of a strategy to ‘encourage’ banks to lend money rather than sit on it.

Understandably, banks are very unhappy; this is effectively a tax on their activities. Many banks even considered withdrawing their cash deposits from the ECB and instead holding them in cash. The security costs of doing so proved too costly to be a viable option. Customer deposits have gone from being an asset on the books of the banks to effectively being a liability. The bank pays the ECB 0.4% on deposits but in most cases do not charge the depositor for holding their cash.

The ECB rejected banks complaints saying the ECB was in business to manage growth and inflation within an economy not to boost bank profits.

The ECB hoped banks would increase lending to the productive sector thereby increasing investment, employment and jobs and ultimately, driving growth and inflation. This is good lending as it increases GDP. Banks instead lent to wealthy individuals and corporations who used that money to purchase property and equities. This drove the value of assets sharply upwards and we can see a very definite growth in the inflation of asset prices. This is the wrong kind of lending, doing nothing for GDP and is simply real estate and financial speculation.

This is exactly the opposite of what the ECB intended. Now, the ECB is pondering its next move.

Under consideration is a three-tiered system, where part of each bank’s deposits would be charged at 0.4%; part would earn zero interest rates and the remaining portion would attract a positive interest rate. Swiss and Japanese central banks have had such alleviation measures in force for years to help their banks. If it happens, it will be positive for banks’ balance sheets and share prices.