Bundesbank chief warns of zero-rate impact on banks

[February 24, 2016]  By John O'Donnell

FRANKFURT (Reuters) - Bank profits will shrink if rock-bottom interest rates stay in place for too long, the head of Germany's central bank warned on Wednesday, signaling that he favors an eventual change in tack.

The remarks from the Bundesbank's influential president, Jens Weidmann, illustrate how seriously Germany is taking the fallout from years of low borrowing rates after a recent crash in bank stocks sucked in the country's flagship Deutsche Bank <DBKGn.DE> .

"The low interest-rate environment particularly weighs on banks' earnings potential," Weidmann told journalists, referring to the market slump.

"The longer the low-interest-rate phase stays, the steeper interest rates fall, the ... smaller banks' profit," said Weidmann, who also sits on the European Central Bank's decision-taking Governing Council.

Early next month, ECB governors will meet to decide whether to loosen monetary policy further, for instance, by extending a 1.5 trillion euro money printing scheme to buy government bonds or by cutting interest rates further.

A cut to the deposit rate, which translates into a charge on banks that park money with the ECB, would penalize banks.

Weidmann referred to a survey of German banks that concluded they would see pre-tax profits shrivel by 25 percent by 2019 as a result.

Should low interest rates remain in place until 2019, he said, profits could fall by up to half. Further cuts to borrowing rates during this time would make their results worse still.

The former adviser to German chancellor Angela Merkel, saying that he hoped interest rates would eventually rise again, played down any threat of deflation or falling prices and predicted that a modest economic recovery would continue.

Falling price inflation is generally considered an economic alarm bell and is typically used as a trigger for ECB action. In talking down such a problem, Weidmann is also playing down the need for any action.

He also voiced scepticism about the proposal to scrap the 500-euro note, saying that Germans still wanted to be free to pay in cash.

"It would be fatal if the impression were to be created ... that the discussion about the scrapping of the 500-euro note ... was a step towards ending the use of cash generally."

(Reporting by John O'Donnell; Editing by Mark Heinrich)

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