Bankers in Davos see ECB's QE plan squeezing profitability

[DAVOS] The European Central Bank's plan to spend at least 1.1 trillion euros (US$1.2 trillion) buying assets, including government bonds, may squeeze profitability, bank executives at the World Economic Forum said.

Banks make money on the difference between their funding cost and the interest they charge on loans - the wider the gap, the greater the profit. That spread, known as net interest margin, will probably narrow further under ECB President Mario Draghi's quantitative easing plan.

"QE means stability for Europe, which is good," Deutsche Bank AG Co-Chief Executive Officer Anshu Jain said on a panel in Davos, Switzerland this week.

"Equally it means very low interest rates and a real destruction of net interest margins, which of course is going to be a huge challenge. So the best parts of our business, deposit-taking businesses, our flow- franchise businesses, will suffer from that."

The ECB president on Thursday pledged to buy 60 billion euros every month through September next year to put more cash into circulation and stave off deflation. While stock and bond markets rallied worldwide on speculation the stimulus will revive European growth, the decline in borrowing costs threatens to dent banks' profitability.

"It creates another problem," said Gary Parr, Lazard Ltd's vice chairman, in an interview with Tom Keene on Bloomberg TV in Davos. "The low level of interest rates net-net on profitability is a negative for the big banks, not a positive."

European corporate borrowing costs are falling. The average rate on investment-grade company bonds declined to 1.05 per cent on Thursday in London, according to Bank of America Merrill Lynch index data. Yields on corporate notes have plunged from about 5 per cent in 2011 as the Frankfurt-based ECB imposed near-zero interest rates in the aftermath of the European sovereign-debt crisis.

The ECB's pledge "means for banks more liquidity, some compression of margins, partially compensated by lower funding costs," Federico Ghizzoni, the CEO of UniCredit SpA, Italy's largest bank, said in a Bloomberg TV interview with Francine Lacqua in Davos.

"Most of QE is already priced in the banking shares because the market was expecting a such move." The STOXX 600 Banks Index jumped 2.7 per cent on Thursday in Europe and advanced again Friday. The 49-member index gained 7.6 per cent this week, heading for its biggest weekly increase in three years.

Even though quantitative easing may pressure margins, bankers said it's needed to help revitalize the euro area and head off incipient deflation. Without government measures to make economies more competitive it won't be enough, they said.

"We need the QE, we need structural reforms, we need fiscal policies, we need banks to be able to lend again, but we need to go a step further," said Ana Botin, the chairman of Banco Santander SA, on a panel on Thursday.

"Otherwise, we're not going to create jobs, which is what we're all looking for."

BLOOMBERG