PERPLEXING MATTERS, by François Leclerc

Guest post. Translated from the French by Tim Gupwell

Two days ago, Christian Noyer, the Governor of the Bank of France, confidently commented on the decision taken by the BCE to put an end to all remuneration on the liquidities parked in the Eurosystem by the commercial banks. The banks prefer placing their holdings in a sure location, rather than lending it out to their peers. 800 billion Euros have recently taken this route – an unprecedented level. As one can see, there is no lack of liquidity in the market, the problem is the use it is put to, or rather not put to.

“We have taken an important step towards discouraging banks from bringing their liquidities to us, and encouraging them to be more active in distributing credit and in terms of investments in the securities markets,” explained Christian Noyer subsequently, who is also a member of the Executive Board of the ECB, expressing the hope that the “banks help revive the interbank market” – the key to the problem in his opinion.

Alas! This is far from what is happening in reality. On the one hand, there are clear signs that the banks still do not trust each other; and, on the other hand, the precautions they are taking – knowing that they will soon have to apply the Basel III measures (if they do not succeed in getting them watered down) – have encouraged them to do nothing more than transfer their holdings from one ECB account to another.

With deposits no longer being remunerated, they have placed a majority of their liquidities into the current accounts which already held their legal reserves (only remunerated at 0.75% for the amount up to the banks’ legal reserve requirements; all deposits greater than this amount receiving zero interest). The funds recorded in this account have passed from 107 billion to 503 billion Euros, which is well beyond their reserve requirements.

There still remains the possibility of paying negative interest on these bank deposits, which would be the equivalent of forcing them to pay in order to rent the safety deposit, but given that they could still place them in the current account, there would simply be no point in doing so.

What is the moral of the story? Can it be concluded that the ECB has simply lost its grip? That its tools no longer work? Or that its directors are demonstrating an incredible naivety, unable to come to terms with the fact that their world has changed?