Drop in Eurozone Bank Stocks May Curb Lending

EghtesadOnline: European Central Bank board member Peter Praet warned on Tuesday that a persistent drop in eurozone bank stocks could curb lending to firms and individuals, underlining concerns within the ECB about the effect of ultralow interest rates on the region's weak banks.

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05 October 2016

It is "crucial" to continue monitoring the implications of the ECB's policies "on the position and prospects of the banking system," Praet, the bank's top economist, told an event in Madrid, MarketWatch reported.

Any recalibration of the ECB's tool kit, "should this be necessary at all," should aim to boost the broader economy without undermining the incentives for banks to lend, he said.

Praet also said he expects very low interest rates to "prevail for an extended period," and called for fresh consolidation in the eurozone banking sector, including cross-border mergers.

Praet—who sits on the ECB’s six-member executive board—said that weak bank equity markets could become a public-policy concern “if they persist and morph into a systemic phenomenon.”

“The profitability of the banking sector is weak, it’s too weak,” Praet said.

Investors' Worries

It was the second time in less than 24 hours that a senior ECB official voiced concerns about eurozone bank stocks. Investors’ worries about low profitability, triggered in part by ultralow interest rates, have pushed European bank shares down about 20% this year.

That is a concern for central bankers in the region, because of a “rather strong correlation” between equity prices and banks’ lending, Praet said.

“When equity prices are low, one year later, you may see impacts on the supply of credit of banks in general,” Praet said.

Speaking in Luxembourg on Monday, Praet’s fellow ECB board member, Yves Mersch, warned that lower stock prices could cause banks to become more conservative in their lending.

“Cutting interest rates even more would come with increasing risks as reactions to such cuts might not always be linear,” Mersch said.

The comments mark a change of emphasis for the ECB, which until recently stressed the benefits of negative rates, and left open the door to a fresh rate cut. At his September news conference, ECB President Mario Draghi said that negative rates didn’t affect the ability of banks to make loans, reports Financial Tribune.

The ECB cut its deposit rate—charged to banks for storing funds with the central bank—to a record low minus 0.4% in March, and accelerated its bond-purchase program to €80 billion a month.

However, eurozone inflation was just 0.4% in September, still far below the ECB’s target of just below 2%. Most economists therefore expect the ECB to boost its stimulus again, probably in December.

Critical of Negative Rates

Praet stressed that any fresh ECB policy action, “should this be necessary at all,” should be aimed at bolstering the broader economy without undermining incentives for banks to lend.

In Germany, the largest eurozone economy, politicians have grown increasingly critical of the ECB’s subzero interest rates. German bankers have been scathing about negative rates, which they have long warned undermine their profits and could lead to higher loan costs.

Shares of Deutsche Bank AG have come under pressure in the past month amid concerns that the bank will pay more than expected to settle mortgage-securities cases with the US Department of Justice.

Draghi was grilled by German lawmakers in Berlin last week about the ECB’s low-rates policies, which some lawmakers complained acted as a “hidden bailout” for indebted southern European governments.

In Madrid, Praet said there is no “strong evidence” that banks’ profits have been hurt by the ECB’s policy measures yet, but he warned that could change over time.

With very low interest rates expected to “prevail for an extended period,” Praet called on governments to help the ECB by addressing banks’ legacy of nonperforming loans and implementing economic overhauls.