Negative interest rates have become more prevalent in the past couple of years in central banks’ bid to shore up growth and stoke inflation. But at what point do they become counterproductive?
Incredible though it seems, there are five central banks that currently have a negative interest-rate policy. Turning conventional practice on its head, commercial banks in Switzerland, Japan, Sweden, Denmark and the eurozone now have to pay to deposit funds at their central bank. The theory goes that as banks are penalised for holding on to excess reserves, they are likely to lend more to businesses and individuals, so stimulating growth and inflation in the economy – things that have largely been lacking in the aftermath of the financial crisis.
Yet following the financial crisis, commercial banks are increasingly risk averse and being encouraged by regulators to increase capital reserves as a buffer for periods of turmoil. Earlier this year, financial stocks across Europe witnessed a sell-off as it became evident that by not passing negative rates onto customers (charging them for having deposits), banks were likely to see margins squeezed.
Conventional theory can be thrown out the window in a negative interest-rate world. A prime example was seen in the Swiss Canton of Zug where penalties for late payment of taxes were removed – as holding excess deposits was actually costing the government! And anecdotal stories abound with regard to the increase in sales of safety deposit boxes in Japan, which demonstrate that there is a level at which individuals will simply withdraw cash and keep it at home rather than pay for the safety of a bank. This does not apply solely to individuals, with German insurer Munich Re announcing that it was to start storing at least $11m in its vaults.
Can Negative Rates
If banks fear that they are likely to see large withdrawals, this might lead to reduced appetite for lending, thereby reducing the availability of credit