As the European Central Bank (ECB) meeting looms on June 5, one of the primary tools the central bank are likely to implement is negative deposit rates, which currently stand at zero. This is aimed to help those seeking credited and loosen the extreme credit tightening seen in the eurozone. Effectively, banks would be charged a negative interest (institutions would lose money) by holding their capital in reserves.
However, it is not a guarantee that banks would lend even if the deposit rate was negative. “There is not much experience and I would be very cautious with this instrument,” said Jamie Caruana, head of the Bank of International Settlement (BIS), which is essentially the central bank of central banks.
The problem for Caruana is that financial markets are based on positive rates, and there is little known about how market structure would perform under negative rates. He also contemplates the risk-to-reward benefit. “The consequences of negative rates are therefore very much unknown. Moreover, the benefits are not obvious,” he continued.
Unless the deposit rate was cut dramatically, financial institutions could find ways to avoid lending in what they deem uncertain times. Banks could avoid lending and decide to shrink their balance sheets (which is not entirely a bad thing given the European banking condition).
A lot is still unknown about what the ECB will announce this Thursday. Several different measures have been floated around as rumors in the last few months, but it is more than likely the central bank will go down the route of unconventional central banks first explored by Ben Bernanke with the Fed and Haruhiko Kuroda from the Bank of Japan (BoJ). The problem is, the benefits from the ECB contemporaries are still unknown and lacking.