Wednesday 17 February 2016 1:22 pm

Morgan Stanley: Negative interest rates are a dangerous experiment that will hit bank lending

Negative interest rates are a “dangerous experiment” that will punish banks and cause lending to contract, Morgan Stanley has warned today.

Analysts at the investment bank warned the pressure on lending margins could make borrowing more expensive.

"With rates set to remain lower for longer, margin pressure is set to be one of the biggest concerns for European banks also in 2016," they said.

"This is all contrary to the ECB’ desire to ease credit conditions and support financial stability."

The European Central Bank began paying negative interest rates on cash kept there by retail banks in December. It has signalled it will cut the deposit rate further to minus 0.3 or minus 0.4 per cent in March. The prospect of negative interest rates has received part of the blame for a sharp decline in bank share prices this year.

"As long as the lower bound is not clear, it's difficult to predict how bank stocks will perform, as minus one per cent negative deposit rates (as some senior policy makers have suggested) would materially impair net interest income in the Eurozone," the analysts said.

"German banks, with excess deposits, also stand out. Sixty percent of all excess deposits at the ECB are from German banks, and we expect loan growth to be poor."

Another concern surrounds the effectiveness of the quantitative easing (QE) programme when deposit rates are negative. QE creates extra bank reserves, meaning banks have to hold more of an asset that they are essentially being taxed on.

"Any expansion of the ECB's QE risks flipping the effect from a positive to a negative for many Eurozone banks, possibly prompting an end to free banking in Europe and starting a battle to shift models to commissions," they said.

"For banks, we argue the best scenario would be no cut in the depo rate, and some expansion of ECB buying programmes."