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Negative European rates could erode bank profits 5-10 pct: Morgan Stanley

By Anjuli Davies

LONDON, Feb 17 (Reuters) - Any further moves into negative interest rates by the European Central Bank (ECB) could erode bank profits in the region by between 5 and 10 percent, Morgan Stanley analysts wrote in a note on Wednesday.

Europe's lenders have lost nearly a quarter of their value, or more than $240 billion, since the start of the year, faced with the threat that spiralling macro-economic worries could undo eight years of cost cuts, safer balance sheets and risk- averse strategies.

There are also fears that negative interest rates, effectively a tax on banks designed to encourage them to lend, have become part of the problem rather than the solution, eroding net interest margins and forcing lenders to charge for deposits.

The Bank of Japan has become the latest central bank to join the sub-zero club, Sweden has taken rates even deeper into negative territory and markets are betting the European Central Bank will shave another 10 or 20 basis points of its minus 0.3 percent deposit rate next month.

"Any expansion of the ECB's QE (quantitative easing) risks flipping the effect from a positive to a negative for many Euro Zone banks, possibly prompting an end to free banking in Europe and starting a battle to shift models to commissions," wrote Morgan Stanley (Xetra: 885836 - news) 's analysts.

Sub-zero rates effectively charge banks that park cash at the central bank, but those costs are difficult to pass on because customers can pull their money out of their accounts and leave the banks with big holes in their balance sheets.

A 20 basis point deposit rate cut would impact Euro area bank earnings by around 10 percent on average in 2017 estimates or between 80 and 90 basis points of their ROTE (return on tangible equity), according to Morgan Stanley.

"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," according to the note.

"With (Other OTC: WWTH - news) rates set to remain lower for longer, margin pressure is set to be one of the biggest concerns for European banks also in 2016."

ECB banking supervisor Daniele Nouy said on Tuesday the euro area bank sector is more resilient than at the height of Europe's crisis in 2012 and lenders are more capable of absorbing any unexpected headwinds. (Additional reporting by Jamie McGeever; Editing by David Holmes)