Rising European Bank Deposits Wind Up at ECB as Lending Sputters

(Bloomberg) -- Banks in the euro zone, flush with new deposits, have turned few of them into loans to companies and consumers. Instead they've parked most of the money at the European Central Bank, where they're paying billions of euros for the privilege of keeping it there.

Since June 2014, when the ECB cut rates below zero, deposits at euro-zone banks have jumped by 802 billion euros ($848 billion), according to central bank data through the end of January. Lending to nonfinancial companies and consumers in the currency area rose by 169 billion euros over the same period, while deposits at the ECB in excess of required reserves soared by 1.1 trillion euros.

Negative rates were supposed to bring down borrowing costs, thereby encouraging lending. But banks in some European countries have cut loans because they're struggling with piles of bad debt and weak capital levels. Where lenders are healthier, there's little demand for funds because of uncertainty about global trade and regional growth. Banking and sovereign-debt crises in some euro-zone nations also curtailed cross-border lending.

“It's demand-side problems in Nordic countries, Germany, Austria and Netherlands,” said Jan Schildbach, head of research for banking and financial markets at Deutsche Bank AG. “And it's supply-side in the south. Deposit growth, especially coming from corporations, is probably a signal of that weak demand in many countries.”

Negative Rates

The ECB has cut its benchmark rate in four stages to -0.4 percent. That means banks pay 0.4 percent annually for the excess deposits they place at the ECB. The interest paid to the central bank last year on those funds: 3.6 billion euros, data complied by Bloomberg show.

If negative rates haven't led to a lending spree, they have at least stopped the slide. In the two years before June 2014, loans to nonfinancial companies and households had declined by 5.2 percent. They rose by 0.5 percent in 2015 and 1.4 percent last year.

Some banks have charged corporate clients interest on deposits, but funds held for nonfinancial companies have climbed 18 percent since rates went negative, according to ECB data. Savings by individuals, who aren't charged for deposits, increased 7.6 percent.

Last March, the ECB went even further, introducing a program to lend to banks at negative rates -- meaning it would pay them to borrow. That only nudged them to borrow 32 billion euros more than the 632 billion they had already drawn down from the central bank.

Sitting Idle

Deposits at the ECB don't necessarily mean money is sidelined. When there's excess liquidity, as has been the case for the past two years because of the ECB's bond-buying program, banks' deposits at the central bank rise. Even when some of those funds are loaned to companies to purchase assets, sellers often deposit the proceeds in another bank, and the money eventually winds up at the ECB.

While there's no way of telling what portion of the central bank's new deposits have cycled through the economy, the gap between deposits and loans shows at least some funds are sitting idle. The banks also have cut their derivatives exposures, lending to other banks and holdings of debt securities since June 2014, which means new funds being deposited aren't going into those outlets either.

Lower borrowing costs may be enough to spur companies to borrow in the U.S., where they can sell debt in public markets. But in Europe, which relies heavily on loans, lower rates don't translate into economic stimulus unless banks participate.

Bank Profitability

Negative rates cut into bank profitability by lowering interest margins. Banks make money on the difference between what they pay creditors and what they receive from borrowers. When interest rates are close to zero, the spread between those two rates narrows. Deposits that aren't turned into loans miss out on even that lower spread and cost banks the interest paid to the ECB.

Net interest income for the 20 largest euro-zone banks fell 5 percent last year, while loan-loss provisions jumped 27 percent, according to data compiled by Deutsche Bank. That resulted in an almost 50 percent drop in net income, to 33 billion euros, the bank said in a March 2 report.

A surfeit of banks in some European countries also hurts profitability, according to Algebris Investments, a hedge fund that focuses on financial institutions.

“Even the ECB has acknowledged that efficient banks help economic growth, but too many of Europe's banks are still inefficient,” said Alberto Gallo, a partner at Algebris. “There are too many banks, too many branches, and there's been too little consolidation.”

Cross-Border Lending

Portugal, Italy and Germany have the least efficient banks in Europe, according to the hedge fund's efficiency index. The inefficiencies are exaggerated when extra savings in one country can't flow to places where funds are needed. Since 2010, banks in northern European nations have cut their exposure to banks, governments and companies in the south.

Growing imbalances between the credits and debits that national central banks have with each other show that capital outflows from periphery countries are continuing, according to Bruegel, a Brussels-based research group. The ECB's quantitative-easing program hasn't stopped that.

“That means a German bank or a fund selling Italian government bonds to the ECB as part of its QE program doesn't send the cash back to Italy,” said Guntram Wolff, Breugel's director. “That also lowers the effectiveness of QE, because the countries that need the monetary stimulus aren't really getting it.”

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

To contact the editors responsible for this story: Peter Eichenbaum at peichenbaum@bloomberg.net, Robert Friedman, David Scheer