ECB faces balancing act as bankers plea for rate reprieve

* ECB worried about cost of negative rate on banks

* Studies options but relief may not be imminent

* Euro zone excess liquidity since the crisis:

* http://reut.rs/1T69xTQ

* And since the start of QE:

* http://reut.rs/1T68P94

FRANKFURT, Feb 24 (Reuters) – The European Central Bank is fully aware that its negative deposit rate is hurting bank profits and is working on ways to ease the pain – but there is little to suggest a reprieve is imminent.

Indeed, the banking sector’s pain will only get bigger if the ECB cuts its deposit rate to -0.4 percent from -0.3 percent on March 10, then possibly to -0.5 percent by the end of the year, as financial markets expect.

Such negative rates are effectively a charge on banks to park their cash at the ECB. They are designed to spur lending into the economy, which is confronted with a new slowdown in global growth and evaporating inflation.

But bank margins on loans have already been shrinking and lenders, particularly in cash-rich countries such as Germany, are complaining that the ECB’s charges are eating into their profits.

The clearest signal yet that the ECB is listening came from Vice President Vitor Constancio last week when he said the effects of further policy easing on banks would have to be mitigated, as central banks did in Switzerland and Japan.

The ECB is working on a number of ideas for a multi-tier deposit rate, several sources with direct knowledge told Reuters, but it is not clear if any of those would be discussed at the next Governing Council meeting.

Multi-level deposit rates were already being discussed in December but did not make it into any final proposals and policymakers at the time called the idea too exotic.

In Switzerland, a -0.75 percent rate is only applied on deposits that exceed banks’ minimum reserves by 20 times. In Japan, it is charged only above required reserves and money supplied as part of the Bank of Japan’s lending programs.

This means that banks are not charged on some deposits.

The ECB could simply implement a two-tier system, charging a bigger penalty rate on deposits over a certain multiple of mandatory reserves, much like in Switzerland.

“This would protect banks from the negative depo rate and give the ECB room to be more aggressive with further rate cuts,” Giuseppe Maraffino, a rate strategist at Barclays in London said.

Maraffino said the ECB could also exempt from the penalty rate any cash borrowed using its TLTRO targeted loan facility, which has to be used to lend to the real economy.

An alternative approach would be to increase banks’ reserve requirements, which are remunerated at the ECB’s refinancing rate, currently at 0.05 percent.

It would be a boon for banks that already have deposits well in excess of those reserves, typically in Germany, the Netherlands and France, with the added benefit that the ECB could maintain its current interest rate framework.

But it would be a difficulty for cash-strapped lenders in countries such as Greece, where capital controls have been in place since June.

NO RUSH?

The ECB can afford to wait as the fallout on banks from the negative deposit rate is limited so far. ECB supervisors also say banks need to adapt their businesses to the low rates, cutting costs and focusing more on fees and less on interest income.

ECB President Mario Draghi has also played down expectations, saying it was not the central bank’s mandate to protect banks’ profitability.

Banks are currently depositing 639 billion euros ($701.75 billion) at the ECB apart from their obligatory reserves.

If this level of excess liquidity were to remain stable for a year, it would cost depositing banks a total 1.9 billion euros based on the ECB’s current -0.30 basis point deposit rate.

But excess liquidity has been growing at a pace of nearly 50 billion euros per month since the ECB expanded its asset-buying program a year ago and is expected to reach around 1.2 trillion euros by March 2017, meaning banks will likely foot a much larger bill.

The prospect of meager profits has also been cited as one of the reasons behind a sharp selloff in euro zone banking shares since the beginning of the year. ($1 = 0.9106 euros)

[Source:- CNBC]