Impact of ECB negative rates move on corporate behaviour unclear
It’s unclear whether a negative deposit rate – as mooted by ECB officials in recent weeks – would trigger corporates to invest excess cash or, given risk aversion and the deficit of demand, continue to hoard cash, say analysts.
Since the global financial crisis of 2008 led to a freezing up of credit markets, corporate treasurers have been forced to re-order their priorities when it comes to cash management and funding.
Before the crisis, they took their ability to fund for granted and avoided carrying excess cash on their balance sheets, instead putting it to work on higher-yielding investments.
That funding model has turned on its head, and treasurers now live by the acronym SLY – security, liquidity and yield.
“Corporate treasurers live by [those] three rules – in that order,” says Martin O’Donovan, deputy policy and technical director at the Association of Corporate Treasurers.
As a result, companies have been accumulating excess cash to avoid another funding crunch, but they have done so at time of historically low interest rates.
O’Donovan adds: “They’ve built up huge cash balances, which is good in uncertain times. But over the last several years, it has been costing companies to hold spare cash yet it is something they’ve had to learn to live with.”
Corporates are facing punitive costs as interests tumble towards negative territory. They face a painful dilemma: increase the yield on their cash by parking it for a longer period, but in doing so, sacrifice short-term liquidity; or take the higher costs on the chin. For the moment, they are taking the latter option.
Ever since Mario Draghi vowed last year to “do whatever it takes” to solve the euro crisis and prevent a break-up of the single currency bloc, the ECB president has earned a reputation for decisive action.
He proved himself true to his word this month by reducing the benchmark rate on November 7 to a record low of 0.25% after inflation in the 17-nation euro region slowed to 0.7% in October, the lowest in four years. The fall in inflation had led economists to predict a possible rate cut, but many expected it to come later in the year.
The move, designed to boost lending by banks and spending by consumers, raised the spectre of negative deposit rates, effectively imposing a fine on banks which refuse to lend.
|ECB executive board member Peter Praet|
ECB executive board member and chief economist Peter Praet said last week that negative interest rates would be consistent with the central bank’s mandate to secure price stability, given the elevated threat of deflation.
The move could have the desired effect and encourage banks to lend money to companies and households instead of keeping it at the ECB. However, it could also hamper their profitability, as they might not be able follow the ECB into negative terrain.
As a result, the spread between the rate banks charge for loans and the amount they pay depositors gets compressed.
In a negative-rate scenario, corporate customers could avoid banks charging them for their deposits by parking their cash on a 30- or 90-day period to secure more yield.
However, O’Donovan believes companies “would rather have access to cash than move out along the curve and take on credit risk”.
Holding large cash balances has become good corporate finance practice, despite the cost associated with it. Another reason corporate treasures like to have cash to hand is to fund acquisitions.
“This is a scenario where the CEO may have negotiated a deal confidentially then needs to pull the trigger quickly,” says one consultant.
While corporate treasurers have become battle-hardened in their acceptance of low yields, falling rates could encourage them to put their cash to work on M&A, or boost capital spending.
O’Donovan says: “The business impact of low rates should be positive because it should be a stimulus to further investment activity.”
The reduction in bank lending has prompted a big shift towards capital-markets funding, with companies exploiting the low-rate environment to lock in financing at record low levels and enable them to follow another post-crisis mantra – diversification of funding sources.
The timing of Draghi’s rate move surprised some because it came as there were signs the outlook for the eurozone economy was improving, leading to suggestions that there are other factors at play.
“Ultra-loose monetary policy is designed to force banks to lend, but it also softens the blow when the three-year LTRO programme starts to unwind,” says the consultant. “As long as interest rates are in positive territory, banks can refinance at low rates and strengthen their balance sheets ahead of the ECB’s stress tests.”