European Central Bank Executive Board member Yves Mersch said banks that can’t withstand temporary strains on their earnings may have bigger questions to answer about their future viability as businesses.
In a speech on Monday, Mersch acknowledged that low interest rates “put pressure on banks’ profitability” and noted analysts forecasts that return on equity may fall to 2 percent from 6.5 percent in some cases.
While ECB estimates show the overall impact of recent stimulus has been net positive, “we cannot ignore such analyses,” he said. “And yet, one also has to ask if a bank that cannot weather headwinds over a few years still has a sufficiently robust business model to stay in the market.”
Mersch’s comments come a week after ECB President Mario Draghi said the financial industry must stop blaming the actions of central banks for their problems and focus on fixing their business models and risk failings. The Frankfurt-based institution has had a negative deposit rate since 2014.
Mersch also said there’s a risk that loss of confidence in the financial industry could hurt lending and the broader economy. The Bloomberg Europe 500 Banks Index has fallen 24 percent this year, almost four times as much as the Stoxx Europe 600 Index.
“A negative outlook for banks weighs on banks’ share prices, thereby raising their cost of capital and ultimately decreasing the net return on lending,’’ he said. “This may cause banks to become more conservative in their lending to euro-area companies and households.”
Speaking in Luxembourg, Mersch warned that cutting rates further “would come with increasing risks” as costs for the banking industry may start to outweigh benefits. While the deposit rate, currently at minus 0.4 percent, is “mildly negative,” he would shy away from moving into “wildly negative” territory.
“There is a limit to how low interest rates can go,” Mersch said. “The longer they remain low, the more pronounced the negative side effects will become.”