Euro zone banks can cope with low rates for years, ECB paper says

FRANKFURT (Reuters) – Bank profits should be able to withstand ultra low euro zone interest rates for up to a decade, a research paper published by the European Central Bank said on Monday, just days after policymakers put off any rate rise.

Some banks have said that maintaining their profitability while interest rates are so low is impossible, making the ECB’s efforts to stimulate economic activity self defeating as weaker banks will not to transmit cheap money to the real economy.

“Although keeping interest rates low-for-long might have negative consequences on bank profitability, substantial adverse effects only materialize after a relatively long period of time and tend to be counterbalanced by improvements in macroeconomic conditions associated with low interest rates,” the paper said.

The euro zone economy is expanding for the 18th straight quarter, its best run since the global financial crisis, with much of the growth fueled by the ECB’s cheap cash, including a deposit rate which has been negative since 2014.

If the macroeconomic outlook remained unchanged, the negative impact on bank profitability could be significant within five years, but economic expansion pushes out this impact, the researchers said in a paper that does not necessarily represent the ECB’s opinion.

“For the first five years the change in expected GDP more than offsets the negative impact on profitability linked to the low-for-long,” the researchers said about the more optimistic scenario. “It would then take about ten years to reduce the profitability of the median bank by 25 percent.”

Return on equity at Europe’s biggest banks supervised by the ECB rose to 7.10 percent in the second quarter, from 5.36 percent a year earlier, ECB data showed earlier.

The ECB has promised to keep rates at their current level until well after it concludes asset buys and markets now see the first rate hike in late 2019, at the earliest.

Supporting its argument, the paper noted that bank equity prices have increased after all major ECB easing announcements, suggesting improved expectations and a positive impact on their credit risk.

For more on the research, click on: https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2105.en.pdf?fe260851eebae3cc673aeb7a62834b19

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