• Analyzing Mario Draghi’s prepared remarks reveals an overt admission that there are possible negative side effects to the European banking sector from the ECB’s negative interest rate policy (NIRP)
  • According to the NBER, financial intermediation is at the nucleus of the savings/investment process in capitalist economies rendering them a central cog of economic growth
  • Cost-ridden European banks are stifling Europe’s economic recovery; Draghi’s calls for the need to consolidate the banking sector emanate from the weight of overproduction of credit
  • A higher unemployment rate in the financial sector will be the upshot of bank mergers; Draghi appears to be on board with layoffs in the sector, despite the obvious consequences
  • Since the ECB imposed its negative interest rate policy, European banks’ loan book exposure to households has risen more relative to that of nonfinancial corporates; additional layoffs may filter through to higher non-performing loans


Skirt on your obligations in 1144 and you’d likely land in the Clink, that is, if you were in the vicinity of Southwark, just northwest of London Bridge. These days, you could meander through the museum on the sight of the oldest men’s prison in London, handling torture devices and imagining what it would be like to be shackled, guilty of having reneged on an obligation. You might find yourself in the unsavory company of heretics, but it was more likely you’d simply be among other debtors in arrears. Though the stigma crossed the pond, debtors’ prisons were banned under federal law in 1933. The Supreme Court affirmed in 1983 the unconstitutionality of incarcerating indigent debtors with reference to the Fourteenth Amendment’s Equal Protection Clause.

Inspired by central banks that put debt on the map, modern-day protections are no doubt welcome in the United States and abroad. We’ve become a debtor nation and a debtor world. Nowhere is the former stigma more pronounced than the European Union where the European Central Bank’s balance sheet has swelled to 41% of GDP.

It’s customary that the outcome of central bank meetings elicits yawns. We form a consensus and the perma-dovish central bankers deliver on our expectations. On the surface, yesterday’s ECB shindig followed that script. But if you know QI, we don’t just scratch the surface.

In Mario Draghi’s prepared remarks about the new series of target longer-term refinancing operations (TLTROs), this caught our eye: “In the context of our regular assessment, we will also consider whether the preservation of the favourable implications of negative interest rates for the economy requires the mitigation of their possible side effects, if any, on bank intermediation.” (“…if any…REALLY?)

There’s an admission here. And it’s couched in a pros versus cons construct.The admission – in black and white – is that there are negative side effects on the European banking sector from the ECB’s negative interest rate policy (NIRP). Of course, Your Honor, we would like to enter the words “possible” and “if any” into evidence.

But take a step back. Consider the importance of a central bank head admitting to its policy having a negative impact on financial intermediation. It should be applauded – and yes, we said that out loud. Why? Because there is acceptance that the monetary experiment we’ve come to know and abhor as negative interest rate policy, also known as NIRP, is not a panacea for all the economy’s ills.

We tagged the National Bureau of Economic Research to help define financial intermediation (bolding ours): “The savings/investment process in capitalist economies is organized around financial intermediation, making them a central institution of economic growth. Financial intermediaries are firms that borrow from consumer/savers and lend to companies that need resources for investment.” Based on that description, the banking system is the engine of economic growth; it takes in the fuel and determines the speed an economy travels.

If the engine in a vehicle is too heavy, its performance will be suboptimal. We’re talking about cost-heavy European banks holding back the pace of Europe’s expansion. These next comments, paraphrased from Draghi’s Q&A session yesterday, clearly elucidate the ECB head’s view on the financial sector in his neck of the woods:

“…What is pretty clear is that the banking system in Europe is overcrowded. The need for consolidation is very, very significant. And part of the structural weakness of the banking system in Europe is caused by this overcapacity in banking which is not the overproduction of credit, it is overcapacity in the number of people, the number of branches. Costs. Some banks have a cost-to-income ratio that is over 80%, 90%…”

Draghi also found it hard to believe some of these banks were complaining about negative deposit rates with such a cost structure. One of his solutions? More digitalization is required. Long fintech, short credulity?

Don’t shoot the messenger. Draghi basically condoned higher unemployment in the European financial sector in the wake of the bloodletting underway in the German auto sector. While that might get some Euro-bank bulls all juiced up, it exposes the economy to the risk of more layoffs…above and beyond the bandied about 30,000-plus tied to a possible Deutschebank-Commerzbank merger.

The risk of higher unemployment would put additional stresses on European bank loan books that have seen exposure grow more to households than to nonfinancial corporates since the initial foray into NIRP in June 2014 (illustrated above). Euro Area households’ debt burden also hasn’t budged much since 2014, going from 106% to 104% of disposable income. So the vulnerability is there.

Savvy investors should be pricing in the unvirtuous feedback loop from banks to households and back as rising unemployment feeds into higher non-performing loans. With all due credit to its chief engineer, “Grazie, Signor Draghi.”