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The European Central Bank is expected to take steps this week that may hit bank profitability but bolster the system in the longer run as it seeks to contain the economic fallout of the coronavirus, according to Goldman Sachs Group Inc.
While a 10 basis point cut to the deposit rate would further hurt the profitability of the sector and reduce resilience in times of stress, better terms on the central bank’s long-term loans to banks would support financial stability and ensure ample funding for companies, analysts led by Jernej Omahen said in a note to investors on Tuesday.
The ECB holds a scheduled policy meeting in Frankfurt on Thursday, and investors expect a 10 basis point cut to the deposit rate, though economists are still divided on whether the Governing Council will act. Some are also predicting bond purchases will be boosted and a measure to direct liquidity to struggling small firms looks likely.
Better conditions on long-term loans would push banks to build up liquidity buffers and eliminate “funding extension risks,” making this an important tool to support financial stability, the analysts said. To make the most of it, the ECB should introduce incentives for all banks to participate, not just those in need, they said.
Goldman economists also expect a “signal” that the ECB could boost the portion of banks’ deposits that’s exempt from negative rates. Greater relief for banks via tiering, as the system is known, would be “critical” in giving lenders another incentive to improve their liquidity positions and protect their profitability, according to the U.S. bank.
“European banks enter this stress period better prepared,” the Goldman Sachs analysts said. While areas of vulnerability remain, “banks are not at the center of this period of stress, and are unlikely to amplify it at this stage.”
Politicians are still mulling measures to help banks and borrowers deal the economic turmoil caused by the spreading illness. The Italian government is negotiating with lenders to provide breaks from debt payments including mortgages, while French Finance Minister Bruno Le Maire has called on regulators to relax rules on nonperforming loans.
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