By David Barwick – FRANKFURT (EconoStream) – European Central Bank Executive Board member Isabel Schnabel on Wednesday said that the ECB’s deposit facility rate, though negative, had probably not reached the relevant lower bound.

In remarks at a roundtable at the 35th Congress of the European Economic Association, Schnabel, according to a text provided by the ECB, said that overall, the positive impact of negative interest rates had dominated and bank profitability had hardly been affected.

Observing that banks could theoretically respond to negative policy rates by increasing the interest they charge for lending, thus mitigating the monetary accommodation negative rates seek to achieve, Schnabel said that this implied the replacement of the zero lower bound by an effective lower bound related to the reversal rate at which policy rate cuts essentially backfire.

‘There is considerable uncertainty as to the precise level of the “reversal rate” and current estimates suggest that the ECB has not reached the effective lower bound’, she said.

According to Schnabel, the introduction of negative rates by the ECB was intended to motivate financial markets to recalculate the expected evolution of short-term rates and to get banks to lend more to the real economy. ‘Empirical evidence suggests that negative rates ultimately delivered on both objectives’, she said.

The impact of negative rates on Eurozone bank profitability from 2014 to 2019 was ‘negligible’, she said, as ‘[t]he negative effects from lower net interest income and the charge on excess reserves were broadly compensated by a reduction in loan-loss provisions.’

Moreover, she noted, the ECB’s tiering system has exempted a large share of excess reserves from negative interest rates, while its targeted longer-term refinancing operations (TLTROs) ensure that banks willing to finance the economy retain access to funds at advantageous rates.

‘In other words, the introduction of a “dual rate” system, where the pricing of TLTROs deviates from our key policy rate, directly lowers the funding conditions of banks and thereby compensates part of the costs that banks accrue by not being able to pass on negative rates to some of their customer base’, she said.

Over the longer term, negative rates harbour risks ‘[i]n spite of the overall positive assessment of the ECB’s experience’, Schnabel cautioned. In particular, she said, ‘It cannot be taken for granted that negative effects on bank profitability from depressed profit margins can be compensated by lower loan-loss provisions also in the future.’

In this connection, Schnabel referred to research supporting the view that ‘absent a forceful policy response, the current pandemic is likely to put substantial pressure on banks’ profitability due to rising loan-loss provisions and defaults, at a time when euro area banks’ profitability is already depressed, mostly due to structural reasons.’

Structural factors are not for the ECB to address, she reminded, citing overbanking and insufficient pan-European merger activity in the sector.

Prospects for growth once the pandemic is over hinge on the degree to which spending, in particular by the European Recovery Fund, supports growth and thus real equilibrium interest rates, she said.

The deposit facility rate is the interest rate imposed on credit institutions that make overnight deposits with the ECB. After staying steady at zero for two years, it was cut to −0.10% as of June 2014. Since then, a further four cuts of identical magnitude have taken it to -0.50% as of last September.

In its policy response to the economic fallout from the pandemic, the ECB has focused on asset purchases and minimized the potential usefulness of additional rate cuts. For example, ECB Chief Economist Philip Lane argued in June that lowering official borrowing costs would have been inferior to the path chosen by the ECB focusing on asset purchases.

Staff analysis suggests that ‘episodes of market stress are associated with a weaker pass-through of policy rate cuts to sovereign yields’, he said. ‘In fact, longer-term sovereign yields become virtually unresponsive to rate cuts in stressed conditions’.