Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Eurozone Banks Are Hoarding Reserves Instead of Lending
Transcript
- Lucas: Eurozone banks are sitting on a record pile of cash parked at the European Central Bank, and they are not lending it out. Luna: That sounds like the opposite of what the economy needs right now. Lucas: Exactly. The latest ECB data shows excess reserves hit nearly 4.5 trillion euros in June. That's money banks could be putting into corporate loans, mortgages, or business investment. Instead, they're earning a guaranteed 3.5 percent on the ECB's deposit facility. Luna: And meanwhile, borrowing costs for companies are still elevated. So banks are choosing risk-free return over lending. Lucas: Right. The ECB's main refinancing rate is at 4 percent, the deposit rate at 3.5 percent. Banks can just park money overnight and earn that with zero risk. Why bother underwriting a loan to a small manufacturer in Lyon or a logistics firm in Milan when the return on reserves is almost as high? Luna: It's a classic liquidity trap, isn't it? Except the liquidity is sitting at the central bank instead of circulating. Lucas: It's a self-reinforcing loop. The ECB tightened policy to fight inflation, which pushed up deposit rates. Banks responded by hoarding reserves. That tightens financial conditions further, which depresses loan demand even more. The latest eurozone bank lending survey showed net demand for corporate loans fell again in Q2. Luna: So the ECB's anti-inflation medicine is also suppressing the very lending the economy needs to grow. What's the way out? Lucas: One idea gaining traction is a tiered reserve system. The ECB would pay a lower rate on a portion of excess reserves, effectively penalising banks for hoarding beyond a certain threshold. The Bank of Japan used a version of this after 2016, and the ECB itself introduced a tiering for the negative rate era back in 2019. Luna: But that was to protect banks from negative rates. Now we're at positive rates. How would it work differently? Lucas: You'd set a multiplier — say, six times the minimum reserve requirement — and apply the lower rate only to reserves above that. So banks would have an incentive to lend out the excess instead of parking it. Some ECB hawks dislike it because it blunts the transmission of monetary policy, but doves argue that the current system is already broken. Luna: And this matters because the eurozone economy is already fragile. Real GDP growth annualised was just 2.1 percent in Q1, up from 0.5 percent, but that's still weak for a recovery. And industrial production has been flat. Lucas: Yeah, the trade-weighted euro has stayed strong too, around 1.14 per dollar, which doesn't help exporters. So you have banks hoarding cash, companies reluctant to borrow, and the ECB stuck with high rates because services inflation is sticky. It's a policy trap. Luna: It reminds me of what happened in Japan in the 2000s. Banks were stuffed with government bonds and reserves, and lending just never recovered until the BOJ started paying negative rates on excess reserves. Lucas: That's the comparison I've been thinking about. Japan's 'zombie banks' were different — they had non-performing loans. Eurozone banks are actually well capitalised. But the behaviour is similar: when the risk-free return is high enough, why take credit risk? And the longer this persists, the more it becomes entrenched. Luna: So what would change the calculus? A rate cut? Or a tiered reserve system? Lucas: Probably both. If the ECB cuts rates, the deposit rate falls, and the spread between lending rates and the risk-free rate widens. But the ECB can't cut aggressively while services inflation is still above 4 percent. So tiering might be the faster fix. Luna: There's also a political dimension. French and Italian banks tend to hold more sovereign debt, so they might be less affected. German banks hold more reserves. So tiering could have uneven effects across the eurozone. Lucas: That's a good point. Bundesbank president Joachim Nagel has been sceptical of tiering for exactly that reason — he worries it could fragment the single market. But supporters say the current fragmentation is already happening, just in the form of different lending rates across countries. Luna: If walking through the economy with us has made something click about how central bank policy actually works — that's because we spend a lot of time digging into these mechanics. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these episodes. No ads, just listener support. Lucas: And we really appreciate it. It keeps us independent. So if that resonates, you know where to find it. Back to the reserves — what's the timeline here? Lucas: The ECB's next meeting is in September. I think we'll hear more debate about tiering, but I don't expect a decision until at least December. The hawks want to see wage data first. Luna: And in the meantime, banks keep hoarding. That's billions of euros not reaching the real economy. Lucas: Billions, yeah. And every quarter that goes by, the risk of a self-fulfilling slowdown grows. If companies can't get loans, they don't invest. If they don't invest, growth stays low. If growth stays low, banks have even less incentive to lend. Luna: It's a textbook case of the paradox of thrift, but at the institutional level. Lucas: Exactly. Saving may be prudent for an individual bank, but when all banks do it, the economy suffers. The ECB needs to find a way to break the loop. Luna: And if they don't, we could be looking at a prolonged period of subpar growth — what some economists are calling 'eurozone stagnation'. Lucas: Already seeing it in the data. The eurozone GDP deflator — a measure of domestic inflation — is still above 5 percent, so real growth is even weaker. The ECB has a tough balancing act. Luna: Alright, we'll keep watching the September meeting. Thanks Lucas. Lucas: Thanks Luna. That's it for today.