FRANKFURT (MNI) – The European Central Bank may hope that a plunge
by more than half in Eurozone banks’ use of its overnight deposit
facility is a sign that banks could begin to increase lending to the
real economy.

Overnight deposits with the ECB plummeted overnight into Thursday
by E483.585 billion to E324.931 billion as the ECB’ Governing Council’s
decision last week to lower its deposit facility rate to zero came into
effect Wednesday.

Overnight deposits fell to their lowest level since December 21,
the day before the ECB’s first round of three-year LTROs settled.
Deposits are also well below the E787.428 billion level seen on the same
day of last month.

ECB Council member Josef Bonnici Thursday called the drop
“encouraging”, according to media reports, saying the ECB’s deposit rate
cut offers an “incentive for the banking system to look what
alternatives there are to improve their earnings … this may lead to
greater borrowing, especially in some member states.”

Deposits with the ECB had surged since the central bank handed out
E1.019 trillion in two three-year LTROs at the turn of the year in a bid
to avoid a massive credit crunch, reaching a high of E827.534 on March 5
and hovering near E800 billion for much of the time since.

Yet it remains to be seen whether the sudden decline in deposit
facility use spurs lending. Indeed, the ECB’s current accounts to cover
the minimum reserve system simultaneously increased overnight by some
E466 billion to E539.786 billon.

“Instead of requesting to place a certain amount in the ECB’s
deposit facility for the duration of 24 hours, banks simply did nothing
when the zero-deposit-rate became effective,” explained Natixis analyst
Christian Ott. “This automatically led to a transfer on the ECB’s
current account. Consequently, the rate cut was not effective in
stimulating the supply of bank loans.”

ECB President Mario Draghi had played down the effect of the
deposit rate cut at last week’s press conference, arguing it would have
more of an impact on expectations for future interest rates than on bank
behaviour.

“Frankly, I do not expect banks’ behaviour to change dramatically
in any way,” Draghi said. “Banks might have an incentive to return what
they had in the deposit facility earlier if they were sure that, for
most scenarios, they would not need that liquidity any time soon.”

“How this is going to affect their business decisions or their
convenience decisions is very hard to predict,” he added.

Draghi has in the past also played down the high deposit facility
levels, urging time for the LTROs to work and stressing that different
banks have been depositing the money back with the ECB than took out
loans through the LTROs.

Still, the ECB Council has shown concern that lending to the wider
economy has not increased, pointing to “subdued” monetary expansion in
Draghi’s opening statement last week and highlighting concerns over M3
developments for May. Private sector lending fell 0.1% in May compared
to the same month last year after rising 0.3% in April.

“Weak MFI lending to the non-financial private sector continues to
stem from both subdued demand and constraints on supply,” the ECB said
in its latest Monthly Bulletin, highlighting continued weak economic
activity and risk aversion holding back demand, as well as ongoing
balance sheet adjustments on the supply side.

“The full impact of the two three-year longer-term refinancing
operations (LTROs) in terms of loan growth – beyond the easing of
constraints on credit supply as a result of improvements in the
liquidity positions of euro area MFIs – is likely to take several
quarters to materialise and will depend on various factors,” the report
said.

— Frankfurt bureau: +49 69 720 142; email: ccermak@marketnews.com —

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