WASHINGTON/FRANKFURT (Reuters) - European Central Bank policymakers are increasingly leaning toward rewarding banks for lending to households and businesses but are mostly skeptical about giving lenders a reprieve from a charge on their idle cash, four sources told Reuters.

FILE PHOTO: Reflection of the sign of the European central Bank (ECB) is seen ahead of the news conference on the outcome of the Governing Council meeting, at the ECB headquarters in Frankfurt, Germany, March 7, 2019. REUTERS/Kai Pfaffenbach/File Photo

With the euro zone economy slowing more than expected, the ECB is again looking for ways to stimulate inflation, but with an increasingly empty-looking toolbox and just months after stopping a 2.6 trillion euro ($2.93 trillion) bond-buying program.

The sources said rate-setters, who met in Frankfurt on Wednesday, were now open to offering a zero or even negative interest rate to banks that pass through into the economy the cash they borrow under the ECB’s third Targeted Long-Term Refinancing Operation (TLTRO III), due to start in September.

TLTRO III, a new series of cheap two-year loans aimed at banks, was unveiled in March as a tool to help lenders finance themselves, particularly in countries such as Italy and Portugal. But policymakers now increasingly see it as a stimulus tool for a weakening economy, the sources said.

ECB President Mario Draghi said on Wednesday that policymakers did not discuss the terms of the upcoming TLTRO at their meeting and would decide on the matter when they have more information about the state of the economy and bank lending, flagging the bank’s June gathering as a possible date.

With the growth outlook fading faster than feared, even hawkish policymakers have given up pricing the loans at the private market rate. Some are even discussing offering the TLTROs at minus 0.4 percent, which is currently the ECB’s deposit rate, the sources said.

Draghi also said policymakers were considering the need to mitigate the impact of the ECB’s negative deposit rate on lenders’ profits, a coded reference to a tiered system where some excess reserves are exempted from that charge.

But this option, which is being studied by the ECB’s staff and has already been adopted by countries such as Japan and Switzerland, met with widespread scepticism on the Governing Council, the sources said.

Many rate setters felt that the relief for banks, which are currently paying a 0.4 percent annualized rate of interest on some 1.9 trillion euro ($2.14 trillion) worth of idle cash, would be modest and outweighed by the risks.

Some fear that investors might interpret the move as a stealth rate hike, which would be particularly felt in countries in the euro zone’s south where cash is still scarce.

Others flagged the risk that tiered rates could be used for an arbitrage in combination with the new TLTROs if banks could access ECB funding at a lower rate than they get on some of their reserves.

HARD SELL

Some analysts said a tiered rate would make room for the ECB to cut its deposit rate farther -- a prospect that one source said was nowhere near being discussed.

Even policymakers who were open to the idea of tiering acknowledged it was a hard sell and would further complicate the ECB’s policy framework, the sources said.

An ECB spokesman declined to comment.

ECB rate-setter and Italian central bank governor Ignazio Visco said the ECB may assess the side effects of its negative rate as soon as June but that the figures at stake were “not very large”.

Negative rates on TLTRO loans are not new. The previous series saw banks borrow at zero and receive a 0.40 percent bonus upon meeting certain lending goals.

This time, the interest rates would be calculated as a spread over, or more likely under, the ECB’s main refinancing operation (MRO), which under normal conditions is the benchmark interest rate for the euro zone.

That would avoid tying the ECB’s hands over changes to that rate during the life of TLTRO III, which will see quarterly auctions being held until March 2021.

The original TLTRO III proposal indicated a premium of 25 basis points above the MRO but it was rejected at the March meeting for being too high.

Not all policymakers are happy with the notion of more ECB largesse. Dutch central bank governor Klaas Knot, a policy hawk, said on Thursday the new TLTRO should be “less generous” than the previous series.