Europe: Who benefits from negative rates?

It is too easy to suspect that the wider politicization of monetary policy in Europe influences some bankers’ attacks on negative rates – in addition to their own self-interest – and particularly in Germany. 

In fact, monetary easing hasn’t just lowered the southern states’ borrowing costs, it has also helped prop up Germany’s manufacturing sector through a lower exchange rate. 

However, there is a valid question – understandably glossed over by much of the European Central Bank’s research – about how the effectiveness of negative rates varies not just between banks but also between countries. Could negative rates be working in Italy, but not in Germany, or vice versa? 

Markus Brunnermeier is the Princeton University professor best known for modelling the so-called reversal rate of interest, at which monetary policy is so negative it becomes counter-productive by curtailing credit supply and making it more expensive. 

According to his research, the reversal rate will be lower if banks have stronger capital levels, if their maturity mismatches are bigger, and if their common inability to pass on negative rates to most retail depositors is less important. 

In other words, if the banks depend more on wholesale funding and the economy relies more on capital markets. 

A good example would be Sweden, where the reversal rate is perhaps as low as -1.2%. Between the big eurozone countries, however, the picture is less clear. 

The gain that banks realise on their sovereign portfolios from rate cuts, according to Brunnermeier, is the main temporary factor that helps make negative rates work. When government bond prices jump, Italian banks should see more of an improvement to their capital. 

Lower corporate borrowing costs are also important to Italian bank’s bad-debt burdens.

Debt volumes

On the other hand, of the big eurozone countries France and Germany – to a lesser extent and especially in corporate sector – have seen the strongest growth in debt volumes since 2014, according to the Institute of International Finance. 

On that measure, negative rates are not working better for southern European banks. 

Without negative rates, southern Europe might have seen loan volumes fall even more. However, fears, partly originating in the legal system, about asset values could be another reason why negative rates do less good in Italy. 

According to Deutsche Bank’s equity research, Italy is the only one of the big three eurozone members where banks are lending less. 

Perhaps Italy and Germany both demonstrate how the problems of banks and the economy in Europe goes far beyond negative rates. 

No amount of monetary policy will work very well in these countries because their banking sectors are structurally weak and because global trade is hurting their manufacturing exports. 

Instead, France may be better-placed to enjoy the advantages of negative rates, according to Brunnermeier, as it has transitioned to a bigger service sector and is now less exposed to demand from emerging markets.