Why the Tearing System Introduced by the ECB Is so Important
On September 12, the ECB decided a 10 basis point rate cut to -0.5%. But even more importantly, they introduced a tiering system, where the exempt tier will be remunerated at 0% and applies to the minimum reserve times six. Both the multiplier and the interest rate can be changed over time. This is a massive relief for the banking sector.
Currently, the European banking system keeps 178 bio in reserves with the central bank. Although the central bank moved down the interest rate on deposits from -0.4% to 0.5%, the reality is that it allows banks to keep money at 0% up to six times the minimum reserve. It means that the European banking system may move between 300 and 500 bio into 0% yielding deposits, moving the money away from negative-yielding securities. Think of it: the new QE is only 20 bio per month (expected 30 bio) and the banks will be incentivized to sell core-European assets: Germany, France and Dutch Treasuries (See Graph 1).
It comes with no surprise that the Governor of the Bank of France joined Weidmann and Knot in opposing this decision. The Governing Council of the ECB seems to be more divided than ever. However, Draghi said during the Conference Call that there was consensus and no vote. A common procedure for the ECB, when most of the Governors are united. But half of the economy of the Eurozone was apparently against it (See Graph 2).
A divided Council combined with the expected selling pressure on Govies had significant impacts on financial assets: Government yields went up, EUR was stronger, equity mixed and Financials positive in Spain, Portugal and Italy.
Regarding the Tearing System:
The Bank of Japan applies a tiering system since January 2016.
The Japanese version of pain relief involves breaking up banks’ deposits into three tiers — one with a positive rate, one at zero and one that is negative.
In Switzerland, the Swiss National Bank is using negative rates to prevent an appreciation of the Swiss Franc. It operates a two-level system, with amounts equal to 20 times a bank’s minimum reserves exempt from any charge. Above that level, an annualized rate of 0.75% is levied on the deposits held at the central bank.
The new European QE is just a placebo, it has very little substance. In reality, the banking system will do much less to support Government bonds. All in all, a zero-sum game.