* ECB poised to stick with zero rates drive
* Policy prompts some free loans, savers to stash cash
* European banks urge change of course
By John O'Donnell
FRANKFURT, Sept 10 (Reuters) - European banks have stepped up their protest against rock-bottom interest rates ahead of a central bank meeting expected to underpin a policy that tramples their profits and has even pushed some to offer free loans.
The president of Germany's powerful savings banks association, community lenders that dominate the country's shopping streets, joined Dutch bank ING on Tuesday in criticising the European Central Bank's loose monetary policy.
"People feel that there is an ever bigger hole in their future pensions," said Helmut Schleweis. "They are saving more because they are not getting any interest."
Low interest rates coupled with penalty charge on banks that hoard cash is making it more expensive for the banks to hold customers' savings and less profitable to lend.
The criticism is aimed squarely at those penalties and the interest rate cuts made by the ECB to buoy the euro zone's economy after the financial crisis.
The problem is particularly acute for Germany's biggest banking sub-sector, the savings banks, which have a glut of money that is expensive to hoard.
Its 50 million customers have increased their savings by almost 5% since last year to 965 billion euros ($1 trillion) - roughly the size of the Dutch economy. With lending amounting to about 860 billion euros, the banks are left with a chunky unused surplus.
Their concern echoes a recent plea by the head of ING for the ECB to change course. Ralph Hamers, who heads the Dutch banking giant, said there was already enough cheap money and that more will not boost weak confidence.
Last week, Deutsche Bank CEO Christian Sewing also predicted that zero rates "will ruin the financial system".
The ECB's stance has prompted heated public debate in Germany, a nation of savers who prefer holding cash to buying shares.
Dietmar Schake, of German safe manufacturer Burg Waechter, said demand for its safes increased by a quarter in the past five years, partly because of fear over interest-free savings.
The ECB policy of charging banks for hoarding cash, introduced in 2014 to encourage them to lend more to bolster a flagging economy, has exacerbated problems for banks but there is no indication of any change in tack.
Amid tensions between China and the United States, Britain at risk of crashing out of the European Union and the German economy slowing, the ECB has all but promised to announce more financial stimulus on Thursday.
ECB officials argue that banks have benefited in other ways, such as through ultra-cheap loans from the central bank as well as the general buoying of the economy and a rise in demand for loans, particularly for homeowners.
As part of the Thursday package, ECB governors are expected to steepen the charges for storing cash, known as negative interest rates, though there may also be some relief from the penalty on some of the money parked at the central bank.
The policy has turned the original banking model - lending on the back of deposits - on its head.
This transformation is underscored by Smava, a German online lender that is paying borrowers to take out small loans. Alexander Artope, who manages Smava, said the offer allows borrowers to profit directly from zero rates, with customers having taken out 20 million euros of such credit.
Smava's offer is smaller but similar to Jyske Bank. Denmark's second-largest lender offers a negative rate on a home loan, in effect paying customers 0.5% to borrow money for 10 years, though administration charges are still levied.
Like the 19-country euro zone, Denmark also imposes a charge on banks that stash surplus cash.
It is a development that has been viewed with increasing alarm across the boardrooms of Europe's biggest lenders, from Germany's Commerzbank to Spain's Santander.
Jean Pierre Mustier, chief executive of Italy's UniCredit and chairman of the European Banking Federation, warned against putting European banks at a disadvantage to U.S. rivals.
Felix Hufeld, who heads Germany's banking supervisor, this year said that every basis point cut below the 0.4 percent penalty charge would cost European banks "a few hundred million euros".
The Association of German banks estimates that euro zone banks pay 7.5 billion euros in penalty charges for hoarding cash, with Germany, France and the Netherlands accounting for roughly two thirds.
Struggling Italian banks, by comparison, pay only 300 million euros, it estimates.
The ECB's stance has also led to suggestions that banks might pass on the cost of negative rates to customers by asking savers to pay a fee, but such a move has its own dangers.
"If a bank introduces penalty charges for normal customers, it would threaten a run on the bank," said Hans-Peter Burghof of Germany's Hohenheim university. "It is playing with fire." ($1 = 0.9064 euros) (Additional reporting by Hans Seidenstuecker Editing by David Goodman)