July 12, 2012 / 7:50 AM / 5 years ago

Banks slash ECB overnight deposits, but sit on cash

FRANKFURT/CASABLANCA, Morocco (Reuters) - Banks slashed the amount of money they parked at the European Central Bank after it stopped paying interest on overnight deposits on Wednesday, but there was no sign they were using it to lend more or buy the bonds of crisis-hit euro zone states.

A structure showing the Euro currency sign is seen in front of the European Central Bank (ECB) headquarters in Frankfurt July 11, 2012. REUTERS/Alex Domanski

The unprecedented cut in deposit rates to zero - approved last week - means banks now get nothing for parking cash at the ECB and officials hope that will nurture more interbank lending by encouraging lenders to look for more profitable options.

ECB policymaker Josef Bonnici said the plunge in overnight deposits - to 325 billion euros from more than 800 billion a day earlier - was “encouraging” and said he expected to see a rise in loans to firms and consumers as a result.

But ECB President Mario Draghi has said he expects little impact on what banks and other investors do with their spare cash. Thursday’s data showed that banks simply shifted much of the near half a trillion euros they took out of the ECB deposit facility into their current accounts at the central bank.

“It’s just a shifting of cash from one place to another and ultimately it’s a zero sum game,” said Simon Peck, rate strategist at RBS.

The current account facility -- which also gives no return but in some respects is easier to use -- jumped to 540 billion from 74 billion the previous day, almost precisely mirroring the change in the overnight figures.

What banks do with the cash from there hangs in the balance but analysts were not optimistic it would lead to a surge in loans.

“Liquidity will remain ample but will be stuck in the current account,” said Patrick Jacq, European rate strategist at BNP Paribas in Paris.

“(For this to change) we need a strong improvement in global conditions, not only in money markets, but in sovereign debt, the economy ... It will take a long time before money market and all market activity is restored to normal conditions.”

SHIFTING LANDSCAPE

An increase in bank lending could breathe life into the flagging euro zone economy, which the ECB said in its monthly bulletin was weak and suffering from “heightened uncertainty” that was weighing on confidence.

Banks are reluctant to lend to each other for fear of not getting all their money back, so they have deposited back with the ECB much of the cash from the central bank’s 1 trillion euros cash boost in December and February.

“Especially the fact that the deposit rate was reduced to zero provides an incentive for the banking system to look what alternatives there are to improve their earnings,” ECB Governing Council member Bonnici told reporters in Casablanca.

Last month the ECB's money market contact group -- a mix of around 20 top traders and a handful of top ECB experts -- said they expected little impact of the rate cut but warned it could hurt interbank trading, push banks out of Europe and further damage their profitability. (here)

Money market experts think the first real impact may come at the end of the year when the zero rate could encourage banks to accelerate the repayment of some of the 489 billion euros they borrowed in the first of the ECB’s ultra-long funding operations, or LTROs, at the end of 2012.

That could drain some of the excess liquidity from the financial system -- some 758 billion euros -- though it is likely that sufficient will remain in the system to keep interbank rates depressed. Euro zone bank-to-bank lending rates hit all-time lows on Thursday.

If the deposit rate cut does not kick start bank lending as they hope, ECB policymakers also indicated on Thursday that they still have other policy options.

“Where necessary, the ECB will use measures already used or new ones.” ECB Governing Council member Jozef Makuch told reporters on the sidelines of a conference in Vienna.

However, he said additional measure were not under discussion and that the bank is not thinking about narrowing the gaps between its main interest rate and the overnight deposit and lending rates which straddle it.

“There is no debate on the corridor at the moment,” he said.

In Casablanca, Bonnici added: “The ECB has still tools to use, but the basis of the problem is the excessive deficit of some member states and this is what needs to be tackled and is being tackled in most of them on a satisfactory basis.”

Additional reporting by Martin Santa in Vienna, and by Ana da Costa and Scott Barber in London; writing by Paul Carrel; editing by Patrick Graham

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