The Swiss National Bank (SNB) today imposed the negative deposit rate as the Russian financial crisis and the threat of further euro-zone stimulus heaped pressure on the franc. Switzerland normally sees money flowing into its coffers in difficult economic times. A charge of 25 basis points or one-fourth of a percentage point on sight deposits of commercial banks at the central bank, will apply as of January 22. That’s the same day as the European Central Bank’s first decision of 2015.
The European Central Bank (ECB) cut a key interest rate below zero, the first major central bank to venture into negative territory. The ECB cut its deposit rate to minus 0.1% from zero on June 5, then again to minus 0.2% on September 4, when President Mario Draghi said interest rates had reached the “lower bound.”
Interest rates have fallen below zero before. Negative deposit rates have been used by a handful of smaller central banks in recent years, including Sweden’s, which cut its deposit rate below zero again in July after a 14-month experiment in 2009-2010 at the height of Europe’s debt crisis. Denmark returned to a negative deposit rate in September, though the cut was aimed at protecting its currency rather than stimulating growth. U.S. Treasury securities traded at negative yields during parts of the 1930s and 1940s, and Switzerland imposed negative interest rates in the 1970s as part of capital controls.
The ECB officials say more stimulus is needed to prevent a slide into deflation, or a spiral of falling prices that could derail the recovery. The cut is part of a combination of measures designed to ensure price stability over the medium term, which is a necessary condition for sustainable growth in the euro area. It’s one way to try to reinvigorate an economy with other options exhausted. It’s an unorthodox choice that the U.S. Federal Reserve Bank and other peers have so far rejected.
The economy of the eurozone is grappling with a shortage of credit and unemployment near its highest level since the currency bloc was formed in 1999. The ECB has particular reason to use negative interest rates. The US Federal Reserve Bank (Fed) and the Bank of Japan have turned to large-scale asset purchases, known as quantitative easing, that create new money to fuel the recovery.
By reducing interest rates and thus making it less attractive for people to save and more attractive to borrow, the central bank encourages people to spend money or invest. If, on the other hand, a central bank increases interest rates, the incentive shifts towards more saving and less spending in the aggregate, which can help cool an economy suffering from high inflation.
In truth, the impact of negative interest rates is uncertain. Proceeding with this move underlines the ECB’s concern and the need for drastic measures to turn around the European economy. It sounds attractive in theory, but it could have unpredictable and unintended consequences. While negative interest rates are normally aimed at institutional investors, in the long-term they can have a detrimental effect on savers, if investors decide to recoup the costs of the rate by levying charges on consumers.
In theory, an interest rate below zero should lower all market rates, thus also reducing borrowing costs for companies and households. In practice, though, there’s a risk that the policy might do more harm than good. Janet Yellen, the Fed chair, said at her confirmation hearing in November 2013 that the closer the deposit rate is to zero, the bigger the risk of disruption to the money markets that help fund banks. A deposit rate cut could hurt banks’ profitability by lowering money-market rates, potentially hampering credit supply to companies and households and reducing banks’ incentive to lend to other financial institutions.
In Denmark, commercial banks aren’t passing on negative rates to depositors for fear of losing customers. When banks absorb the costs themselves, it squeezes the profit margin between their lending and deposit rates, and might make them even less willing to lend.
Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. A deposit rate below zero effectively punishes banks that have extra cash but are reluctant to extend loans to weaker lenders.
Banks are starting to charge their customers for depositing large amounts of euros, passing on fees imposed by the ECB, rather than paying interest. They said that the changing regulatory landscape has made it harder to eat the cost, as they might have in the past. The reversal from paying interest to charging it comes after the ECB started charging 20 basis points or two-tenths of a percentage point, in fees for funds parked at the bank.
Deutsche Skatbank, a division of VR-Bank Altenburger Land, which was founded in 1859, is not the biggest bank in Germany, but it’s the first bank to confirm that retail and business customers with over €500,000 on deposit as of November 1 will earn a “negative interest rate” of 0.25%.
Commerzbank AG is the first major lender in the eurozone to pass this negative interest rate policy on to its institutional clients when they announced it on November 19. Other major banks viz. Deutsche Bank, Bank of New York Mellon, Goldman Sachs, JP Morgan Chase have also decided to selectively pass on the negative interest rate policy.
The latest move by the banks is notable because so many of them are taking the step, giving customers fewer options for moving their money. With the global economy still fragile, negative rates remain a tool that banks could use. Only time will tell whether the outcome of negative rates will in fact be positive.
Detusche Welle, “Commerzbank imposes penalty on big depositors“, (November 20, 2014).
European Central Bank, “Why has the ECB introduced a negative interest rate?“, (June 12, 2014).
Randow, J, “Less Than Zero — When Interest Rates Go Negative“, Bloomberg QuickTake (December 18, 2014).
Richter, W, “The Wrath of Draghi: First German Bank Hits Savers with ‘Negative Interest Rates’“, Wolf Street (October 30, 2014).
Schneeweiss, Z. and J. Schwalbe, “Swiss National Bank Starts Negative Interest Rate of 0.25% to Stave Off Inflows“, Bloomberg News (December 18, 2014)