Nearly half of the developed world now has negative interest rates and the other half are heading that way too.
How does this affect business and individuals?
You have to pay the banks to save your money: with negative interests it means you have to pay the bank to hold your money.
With interest rates heading below zero eventually people will quickly realise that they’re better off withdrawing their money and holding physical cash.
Let’s say you have a $200,000 in your savings account and interest rates are negative 1%, you’d have to pay the bank $2,000 each year. Clearly it would be very tempting to just buy a safe and put your money in it.
It’s as though someone offers to store your cherry pie. Then he goes and eats the pie, promising to give you one just like it when you want it. He then has the cheek to charge you every month for ‘storing’ the pie. And when you want it, he won’t be able to give it to you.
You have to pay interest on bonds: if you loan the Government money you have to pay them interest every year. Sovereign bonds, such as US treasuries or UK Gilts, are a form of government debt that you can buy. Basically you loan the government money and they pay you interest every year. With negative interest rates you now have to pay the government interest every year for the privilege of parking your money into the ‘safety’ of their debt.
A quarter of all global bond holders are now paying interest on their government bonds.
According to Bloomberg the amount of global negative yielding debt has just topped $11.7 trillion at the end of June 2016.
The chart below shows the total negative yielding debt broken down into short and long term debt.
In the second half of 2014 a significant portion of debt began to move towards negative yields.
Looking at the chart below we can see the majority of negative yielding debt is currently in Japan, followed by Europe.
But I’m from the USA / United Kingdom / Canada. We’d never get negative interest rates like Japan and Europe, that’s nuts…
- United States – the Federal Reserve (Fed) has acknowledged that negative interest rates are being considered.
- Canada – the Bank of Canada (BOC) has acknowledged that negative interest rates are being considered.
- UK – the Bank of England (BOE) has acknowledged that negative interest rates are being considered. In July 2016 the Royal Bank of Scotland sent a letter to its business customers warning is may have to impose negative rates in the future.
Turn the heat up slowly so the frog in the water
Banks in Europe have been reluctant so far to pass on negative interest rates to its customers. This is mainly because we are in uncharted waters – never before have we seen such a widespread adoption of negative interest rates and naturally there is a fear of a back lash with people yanking money from the system and stuffing it in the mattress. However, banks will not want to bear the burden of negative interest rates and will be keen to pass it on. This means it would be in the interest of the banks to slowly roll out negative interest rates to its customers. The most likely route of how negative interest rates will be introduced are as follows:
Business customers –> retail customers
Small banks –> large banks
Large cash balances –> small cash balances
As an example, in November 2015 the Alternative Bank Schweiz, which is a small bank in Switzerland, was one of the first to introduce a negative rate. This was imposed on its business customers with cash balances greater than 100,000 Swiss Francs. Several months later the small German bank of Raiffesisen Gmund am Tegernsee became one of the first to start charging retail customers negative interest rates with large cash balances. Here we can see the transition from business to retail customers is already occurring with smaller banks. Of course larger banks are watching and we have already seen Julius Baer introduce negative interest rates (see below). Of particular note, in July 2016 the UK’s Royal Bank of Scotland sent letters to its business customers warning it may have to introduce negative rates in the first. This is interesting because the Royal Bank of Scotland is a large bank and the UK doesn’t have negative interest rates. This shows us two things. First banks in the UK see the real possibility of negative interest rates coming to the UK. Secondly, by sending out letters in advance they are essentially warming the water up so their customers get used to the idea.
“What you’re seeing is there have been a few banks in Germany and a couple in Switzerland which have started to charge for deposits; importantly, it’s to corporate customers, or very wealthy people,” said Andrew Lowe, an analyst at Berenberg, quoted by the FT. “You are likely to see the UK banks follow suit, in particular if rates fall further,” he added. “Everything that applies to Europe applies to UK banks as well.”
Why are central banks putting interest rates negative?
Quite simply because the economy is really bad.
The idea is to boost the economy by encouraging banks to lend rather than hold onto funds, and businesses and people to borrow and spend instead of saving money. This is why during times of recession central banks will usually lower interest rates.
Japan has had interest rates at near zero for more than twenty years following its infamous economic crash and stagnation. As a result of the 2008 financial crisis and recession much of the developed world (including the US, Canada, UK and Europe) cut interest rates to zero and have not raised rates in several years.
Only the USA has attempted to hike interest rates starting in December 2015. However, they only managed a 0.25% hike to 0.5%. There are serious doubts over whether the US will continue to hike rates. the last time the US tried to hike rates into a weakening economy was during the Great Depression nearly one hundred years. The hike then caused the economy to plunge again back into recession.
After several years of massive money printing and zero interest rates the economy’s momentum has not only failed to reach escape velocity, it has seriously weakened. This is pushing many central banks, who have little ammunition left, to turn to or seriously consider the extreme action of negative interest rates.
There are two major side effects to negative interest rates that central banks must overcome:
- damage to the banking system
- cash hoarding
Both of the above are covered in the next few sections.
Negative interest rates hurt the banking system
The major side effect of negative rates is that it hurts the banking system. A cut to official interest rates feeds through into money markets, moves exchange rates, and affects asset prices and wholesale borrowing rates. Commercial banks generally react by lowering the rate they charge borrowers. Normally banks push the cost onto depositors (savers) by lowering interest rates. However, obviously putting interest rates negative would seriously deter people from saving money in the banks. That means that once official rates hit zero, further cuts reduce banks’ lending rates but not their borrowing rates. That squeezes their net interest margin—the main way they make money.
Analysts at Morgan Stanley warn negative rates are a ‘dangerous experiment’, particularly for the banking sector. ‘We are concerned it erodes bank profitability, creating other systemic risks,’ they said.
Germany’s Deutschebank was one of the first big banks to lash out calling on central banks to stop it. In February 2016 the bank issued a note warning that with the Zero Lower Bound already breached in nearly a third of global markets, the benefits to risk assets from further easing no longer exist, and in fact it says that while central banks have hoped that such measures would ‘push investors out the risk spectrum’ the ‘impact has been exactly the opposite.’
How are they cushioning the blow to banks?
Below I will briefly cover how some central banks are using tier rate systems that should allow banks to remain profitable even in a negative interest rate environment.
Tiering mechanisms have been introduced by the Bank of Japan, Swiss National Bank, and Denmark’s National bank. In the case of Switzerland each bank is allocated a threshold by the Swiss National Bank—usually 20 times its reserve requirement. Only reserve balances in excess of that threshold attract the negative interest charge. Cleverly, the threshold gets reduced if banks withdraw their reserves and hold cash—so as to prevent them from avoiding the charge by hoarding banknotes. Denmark’s central bank does something similar. It imposes a limit on reserve balances that do not attract negative interest. Any excess is converted into ‘certificates of deposit’, which attract a charge of -0.75%.
The Bank of Japan (BOJ), which implemented negative rates in January 2016, is using a three-tier interest rate system. The three tiers: pre-existing reserves, macro add-on and new reserves.
Pre-existing balances (old balances) will continue to earn interest.
New Reserves. Negative rates will only apply to new reserves created by the central bank’s continuous quantitative easing (money printing).
Macro add-on. As the stock of reserves in the system grows the Bank plans to increase its ‘Macro add-on balance’—which receives 0% interest—so that only banks’ marginal reserves attract the negative rate.
Negative interest rates will encourage cash hoarding
Putting interest rates negative crosses a psychological threshold with most people – it will encourage people to hoard cash.
This was confirmed in a recent survey by ING international.
Overall only 23% of savers would not react to negative interest rates and a smaller proportion still would save more. Four-fifths would move at least some of their money out of their savings accounts. Some of this might find its way into other bank products, but more than a third say that they would take some of their money out and hoard it.
How will central banks overcome this? Discourage and restrict cash. I have already covered this on detail, see this page for more war on cash.
Negative interest rates are fuelling instead of soothing market fears
Initially there was a positive reaction when central banks began discussing negative interest rates. It helped bolster sentiment and ended the debate on whether central banks are running out ammunition. However, that positive sentiment is souring.
Michael Pearce, a global economist at Capital Economics, said: ‘Policy loosening has fuelled, rather than soothed, market fears.’
Negative interest rate events
Negative interest rates have been tried before in the past, but never on a large-scale. However, this began to change dramatically starting in 2014. Below is a list of negative interest rate events arranged in chronological order:
July 2009 – Sweden (-0.25%)
Between July 2009 and September 2010 Sweden cut the deposit rate to -0.25% in response to the financial crisis, banking crash and recession.
June 2014 – Eurozone (-0.1%)
The 19 countries in the single currency area have had negative rates since June 2014 when it was set at -0.1%.
July 2014 – Sweden (-1.25%)
Sweden reintroduced negative rates in July 2014 and has now cut the negative rates even lower to -1.25%.
September 2014 – Denmark (-0.75%)
After a brief period of being back in positive territory, it imposed a -0.75% rate on certificates of deposit from September 2014.
December 2014 – Switzerland (-0.35%)
Introduced a negative rate in December 2014. However, it has experimented with them in the past; in 1972 it put a 2% penalty charge on deposits by non-residents.
February 2015 – Sweden, first country to impose negative repo rates
Sweden’s central bank became the first country to lend at a negative rate when in February 2015 it announced a negative repo rate – its main lending rate to commercial banks.
September 2015 – UK negative rates on the table
The UK’s Bank Rate has been on hold at its historically low 0.5% for several years. The Bank of England’s chief economist Andy Haldane delivered a speech in September discussing how Britain could have to consider negative interest rates as an extreme measure in a future crisis.
November 2015 – US negative rates on the table
In November 2013 the U.S. Federal Reserve chair, Janet Yellen, said a deposit rate that’s positive but close to zero could disrupt the money markets that help fund financial institutions. Just two years she said a change in economic circumstances could put negative rates ‘on the table’ in the United States.
November 2015 – Swiss bank ABS charges negative rates
The Swiss bank Alternative Bank Schweiz becomes the first to charge savers with negative interest rates. The bank told its customers they would face a -0.125 per cent rate on their money from 2016 and a -0.75 per cent rate on deposits above 100,000 Swiss francs.
‘The decision on negative rates is costing us a lot of money – pretty much the equivalent of our entire annual profit last year,’ Martin Rohner, chief executive of ABS said.
December 2015 – Eurozone (-0.3%)
Following June 2014 the deposit rate was cut further to -0.2% and then to -0.3% in December 2015.
Other banks including UBS Group AG, Credit Suisse Group AG and J. Safra Sarasin Holding AG have levied charges on some cash accounts.
January 2016 – Japan (-0.1%)
Japan surprised everyone on Friday January 29th when the Bank of Japan announced the current easing program would not be expanded and interest rates were cut -0.1%. They also signalled their willingness to do more, saying they would ‘cut interest rates further into negative territory if judged as necessary. What was surprising was that just a week before Japan had said it had no plans to introduce negative rates.
(Bloomberg) — The Bank of Japan pushed interest rates below zero Friday, after years of keeping them at the lower end of the positive range. Bank of Japan Governor Haruhiko Kuroda is matching European Central Bank President Mario Draghi in pursuing negative interest rates, and even pulling ahead when it comes to driving longer-term bond yields lower.
February 2016 – Swiss Julius Baer charges negative rates
Julius Baer Group Ltd., Switzerland’s third largest wealth manager, is passing on the cost of the central bank’s negative interest rate to its institutional clients.
Clients such as pension funds, which use Julius Baer for custody services, will have to pay for deposits in Swiss francs, Jan Vonder Muehll, a spokesman for the Zurich-based firm, said in an e-mailed response to questions on Thursday.
Julius Baer will decide ‘at a later stage’ whether to pass on the costs to private clients, who contributed the bulk of 396 billion francs ($416 billion) under management at the end of 2014, he said. It is advising private clients on ‘interesting alternatives to holding cash.’
February 2016 – US says ‘be prepared for possibility of negative rates’
US Federal Reserve chair Janet Yellen said that the US should be ‘prepared for the possibility’ of negative interest rates. In other words, the next recession the US is putting rates negative.
March 2016 – Norway says ‘will not exclude the possibility of negative rates’
‘The current outlook for the Norwegian economy suggests that the key policy rate may be reduced further in the course of the year,’ Oeystein Olsen said. The Norges Bank also said it ‘will not exclude the possibility of negative rates.’
March 2016 – Eurozone (-0.4%)
The European Central Bank cut interest rates again by 0.1%, lowering the interest rates to -0.4%.
May 2016 – Singapore branch of Swiss Julius Baer imposes negative rates on its retail customers
Singapore doesn’t have negative interest rates, however customers are still exposed to negative rates. The bank informed its customers that from June 2016 an interest rate of -0.4 per cent a year will be applied if a cash balance exceeds 100,000 Euros, while a rate of -0.75 per cent will be levied for a cash balance of more than 500,000 Swiss francs. Other currencies affected include the Danish krone and Swedish Krona.
July 2016 – Dutch bank ABN AMRO gets ready to charge negative rates to business customers
One of the largest Dutch banks, ABN Amro, is updating its terms and conditions and to include the right to reduce the interest rates below zero as the bank wants to ‘protect itself’ against the continuously changing market circumstances.
July 2016 – UK Royal Bank of Scotland (RBS) and Natwest warn it may charge negative interest in the future
In a letter to its customers RBS and Natwest warned customers they would charge negative interest rates if the Bank of England cuts interest rates below zero. Just to highlight just how unorthodox central bank policies have become, should negative interest rates be charged it would be the first time in UK history.
August 2016 – German bank becomes first in Europe to start charging negative interest rates on retail savings accounts
Raiffesisen Gmund am Tegernsee stated as of September savings in excess of 100,000 Euros will be charged a negative interest rate of -0.04%. This is the first bank to pass on negative rates directly to retail depositors in the EU.
August 2016 – Ireland, Bank of Ireland to begin charging negative interest
Bank of Ireland will charge its large corporate and institutional customers a negative rate of -0.1% for deposits of €10 million or more starting in October. This marks the first bank in Ireland to charge negative rates to its customers.