What is the ECB's deposit facility?
The ECB acts as a bank for commercial banks. It enables banks to borrow money from it, and place money with it under certain conditions. The ECB applies various interest rates to these different facilities. The deposit rate is the return that euro area banks get for placing money with the ECB. Before the crisis, the deposit facility was hardly used, as the ECB aimed to lend exactly the amount of money that banks needed. In response to the crisis, the ECB made extra loans available to the banking sector as the interbank money market was no longer functioning as it should, and banks were reluctant to lend to each other. The result of these additional ECB loans is that for the past years a liquidity surplus existed in the euro area banking system, which banks have placed at the deposit facility with the ECB. A negative deposit interest rate means that the ECB will charge banks to park their surplus liquidity with it.
Why has the ECB made the interest rate on its deposit facility negative?
The ECB's objective is to sustain price stability in the euro area, which is defined as medium-term HICP inflation of below, but close to 2%. The outlook for inflation has, however, been downwardly adjusted these past few months. The ECB currently projects inflation to land at 1.5% at the end of 2016. In view of the inflation outlook, the ECB on 5 June 2014, as part of a package of measures, lowered all of its policy rates. This means that the deposit rate has turned negative (-0.1%), as it already stood at zero (note 1).A negative interest rate on its deposit facility is a novelty for the ECB. However, the Danish and Swedish central banks took temporary recourse to this measure previously, while the Swiss central bank lent money to banks at negative interest rates. The Swedish case is actually less relevant as the effect on the interbank market was marginal, but in Denmark and Switzerland interbank rates temporarily moved close to zero, or turned negative. However, it should be noted that the decision to move to negative interest rates in Denmark and Switzerland was motivated by a different purpose, as the reduction was intended to influence the exchange rate of the national currencies against the euro.
Savings rates paid by banks are expected to fall, but should not turn negative
The interest rates that the ECB applies to the facilities that it makes available to banks are usually passed on by banks to their customers. This applies equally to interest rates that banks pay out on retail deposits and the interest rates they charge for the loans they provide. The savings rates that banks in the euro area and in the Netherlands pay out on both demand and term deposits held by their customers are currently well above 0%. Savings rates will continue to be positive even if the banks fully pass on the ECB's 0.1 percentage point deposit rate cut. In other countries where central banks have used the instrument of negative interest rates before, savings rates have remained positive. In both Switzerland and Denmark, the interest rate reductions were only partially passed on to savings rates. This may be explained by the fact that retail deposits are a major, stable, and consequently very welcome source of funding for banks.
Effect on lending rates, both for mortgage and corporate loans, cannot be determined exactly
Bank lending rates are based on their own funding costs, consisting of various components, including deposits, wholesale financing and equity capital. Although a reduction seems likely, the exact effect of the ECB's interest rate cut on the costs of the various forms of funding is impossible to determine exactly, because these are also influenced by many other factors. The ultimate effect on bank lending rates therefore cannot be determined exactly. In Switzerland and Denmark, bank lending rates for both households and businesses fell slightly at the time.
Note 1. For a further explanation of the effects of the ECB's interest policy on inflation (monetary transmission) and more information on the operational implementation of monetary policy in the euro area, we refer you to the ECB's website (Transmission mechanism of monetary policy/Monetary policy instruments).