For the last two years the European Central Bank (ECB) has initiated a zero- or negative rates policy: its key rate fell to zero, and when a bank deposits cash at the ECB, not only does it not yield anything like before, but the bank must pay a yearly 0.4% interest rate. Mario Draghi’s goal is to discourage banks having their cash sitting idle and to lower the cost of credit in Europe in order to revive economic activity. The cost of money has been lowered for sure, but the volume of credit has only grown a little, not enough to get out of zero growth...
On the other hand this long-standing monetary policy generates a massive and catastrophic perverse effect: banks are no longer profitable. In other words, this policy pushes them into bankruptcy. This is what no less than the IMF explains in a study from last August 10. This fall in profitability happens differently depending on the banking systems:
- In countries with important trade surpluses (Germany, Netherlands), banks are having trouble recycling the massive deposits arising from it and are even more penalised because of the low rates.
- In countries where lending rates are variable and indexed on the ECB’s key rates (Belgium, Spain), banks lose money on new loans, but also on outstanding loans having lower rates. The value of that credit in their books is dropping and the revenue flow is dwindling.
- Faced with this drop in interest rates, certain countries are able to compensate in part by some growth in credit volume, but how long will this last? Other countries are not able to compensate (Italy, Spain), which puts their banks under pressure.
According to the IMF, this decline in profitability weakens the banks and will lead them to diminish their loans into the economy, which is precisely the opposite of the expected result to start with! This is another proof that economic interventionism never works, that it even deteriorates the global situation. After the states, central banks are starting to understand that, albeit much too late.
Although the IMF doesn’t state it explicitly, such a crash in profitability will lead to serial bankruptcies if the movement is not reversed. And, for multiple reasons, a rate hike is nearly impossible today (amount of sovereign debt, weight of derivatives, destabilisation of banks’ and insurers’ balance sheets, massive losses for central banks etc.). The fact that banking shares are being massacred on the stock market is not an accident.
As we’ve said before, there is a way out for savers: physical gold, which is becoming even more interesting in a context of negative rates... and failing banks.
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