Long before central supervision of the 120 most important banks in the euro zone was placed under the umbrella of the European Central Bank, experts had warned that a central bank would quickly face conflicting goals if it had to simultaneously guarantee price levels and financial market stability.
Critics argued that a central bank could easily be tempted to refrain from raising interest rates, even if it made sense in terms of monetary policy, to avoid causing problems for individual banks. And that its reputation as the supreme financial regulator would suffer as a result.
And while many things have defied these predictions, that hasn’t been the case on all fronts.
At the moment, no one is talking about interest-rate increases in the euro zone. Instead, the ECB’s zero-interest rate policy, combined with negative interest on deposits banks park with the ECB, is increasingly weighing on the margin of interest and, therefore, the earnings of commercial banks.
But let us not forget that a profitability crisis can quickly turn into a solvency crisis.
The ECB's current monetary policy has finally merged into a race against time.
On the liabilities side, individual lenders have avoid charging negative interest on deposits for as long as possible to maintain customer confidence. And they certainly wouldn’t want to be the first to take this step, fearing a loss of market share. But other risks lurk on the assets side of their business.
Low-interest loans to companies are by no means unproblematic, if this means that extensive lending funds are tied up longer than is reasonable for timely adjustment to a new interest cycle. But if banks attempt to take advantage of borrowers through excessive fees, it will alienate long-standing customers.
Yet we know all to well that the alternative search for higher yields by commercial banks is associated with higher risks. Less by choice than by necessity, an increase in equity capital, widely demanded by regulators and investors, may have to be accelerated by issuing shares instead. The problem is: How should these shares be made palatable to potential buyers, given these low interest rates and unfavorable expectations?
While the sale of a bank’s own assets would be an option for reducing their debt, such higher equity ratios, achieved through the reduction of total assets, would more likely further inflame the crisis of confidence in the banking sector and promote the path to deflation through debt relief. The stability of the financial market sector would continue to suffer.
It turns out that the ECB is in a dilemma quite similar to the one described above, and somewhat earlier than previously anticipated. Should the zero interest-rate policy, together with quantitative easing, fail to achieve the desired rate of inflation of just below 2 percent quickly enough, the potential imbalance of euro-zone banks could force the ECB to step in as a supervisor.
This is in no one’s interest, which is why the ECB’s current monetary policy has finally turned into a race against time.
To reach the author: email@example.com