* Design and size of the scheme disappoint
* Discount will only save banks up to 3.1 bln euro
* Peripheral banks may see wholesale funding dry up
* Pledge to keep rates low to hurt banks for years
By Francesco Canepa
FRANKFURT, Sept 12 (Reuters) - The European Central Bank isgiving euro zone banks a small reprieve from a penalty charge ontheir idle cash but this is likely to prove too little, too latefor a sector hurt by years of low interest rates.
In its latest bid to shield the euro zone's economy from aglobal economic slowdown, the ECB pushed its deposit ratefurther below zero on Thursday - effectively increasing how muchit charges banks for keeping their excess cash overnight.
It was part of a package that also included a pledge to buyassets and keep rates low or even cut them until inflationreturns to the ECB's target of just under 2 percent.
To cushion the latest blow to an already ailing industry,the ECB introduced a so-called tiered system of interest rateswhereby a portion of bank deposits, currently set at six timestheir mandatory reserves, is exempted from the charge.
But the size and design of the scheme, inspired by one usedby the Swiss National Bank, left observers underwhelmed.
For starters, the exemption would result in an annual savingof only 3.1 billion euros for the entire euro zone bankingsystem, or a just over a third of what the cost would have beenwithout it, according to Pictet estimates.
And this calculation may overstate the actual benefit of thetiered rate as excess liquidity is mostly concentrated at largerbanks in richer countries such as Germany and France, meaningthe scheme won't be exploited to its maximum.
"Even if the tiered interest rate introduced today providessome relief, European banks will continue to have to paybillions to the ECB every year as some sort of penalty chargetax," Hans-Walter Peters, president of the German bankingassociation, said.
Second, the blanket exemption for all banks could even causea rise in borrowing costs for some banks in countries, such asItaly, given that the wholesale funding market is still largelydivided along national lines.
This meant that larger peripheral banks that currently lendtheir excess cash to their domestic rivals at negative ratescould now choose to park it at the ECB for free, deprivingweaker banks of a key source of financing.
On the upside, banks that are confident of meeting the ECB'slending targets can be paid 0.5% to borrow cash at the centralbank's multi-year auctions and then simply place it in theiraccount at the tiered rate.
The ECB reserved the right to change the exemption thresholdand the rates charged below and above it "such that euroshort-term money market rates are not unduly influenced".
But even so the benefits of the tiered rate were likelyoutweighed by the pledge to keep the money taps openindefinitely, which was already depressing market interest ratesfor years to come.
"What is clear is that the ECB is not driven by bankprofitability concerns," Marco Troiano, a director at ScopeRatings, said. "The open ended guidance will further flatten thecurve, which kills bank profitability."(Reporting By Francesco CanepaEditing by Chizu Nomiyama)