Banking Crisis

EDITORIAL COMMENT: The Continuing Pain Of Negative Interest Rates

Tom Burroughes, Group Editor, London, 4 August 2017

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Official data issued a few days ago reminded bankers of the cost of negative interest rates, a feature of the post-2008 financial crisis world.

When bank economists talk about a return to interest rate normality they may not yearn for the high single-digit or double-digit percentage rates of old but they certainly will want to see a move away from the bizarre era of negative rates.

When interest rates are negative, those who deposit money in banks pay an additional amount to do so; they are actually paying for the privilege of putting money into a bank account above any sort of commercial “storage fee” that might have operated in a complete free market. Negative rates operate in Switzerland, Denmark and Japan; and with official rates in other countries sometimes lower than headline inflation, real as well as some nominal rates are negative in many other developed nations.

Banks are hit in such an environment because individuals and businesses obviously want to keep their cash intact as much as possible and will be reluctant to entrust money to banks. Banks’ margins are hit, and Swiss banks have suffered, for example, adding to the pain caused by the exodus of money caused by the demise of bank secrecy. It is a measure, though, of how highly regarded Swiss banks are for stability that as much money as is the case remains in these institutions.

Remember, one function of banks is to be storage facilities for money; they charge money for safe keeping of that money (the idea that banking should be “free” is economic nonsense, since banking systems have to be paid for by someone), but negative rates are a clear disincentive to deposit cash. Sure, central bank policy, in this age of quantitative easing, is about encouraging people to avoid the safety of cash and go into riskier areas such as equities, with the idea of boosting economic growth. But for many people who value liquidity, being forced to hold risky assets to avoid erosion of value is a harsh trade-off.

And almost a decade on from the worst financial crisis since the 1930s, that this situation still exists is testing bankers’ patience.

This negative rate environment also explains why central banks such as the European Central Bank and the Reserve Bank of India have cracked down on high-value notes. On the face of it, such crackdowns are designed to foil criminals, but there is another factor that policymakers are less keen to stress: it is hard to engage in “financial repression” via negative interest rates if people shun the banking system and keep banknotes under the bed, so to speak, or hoard gold and other substitutes for fiat currency. One can imagine a situation, for example, where a person buying goods or services in a Swiss store might get a discount if he or she pays in banknotes rather than via a debit or credit card. Authorities will no doubt try and stop this, and the “war on cash” has been a feature of government policy for some time (ostensibly to stop tax evasion/avoidance), but one cannot help thinking that cash is frowned on by the powers-that-be because it stymies monetary policy.

And the sheer cost of negative rates is cumulatively heavy, as shown by figures a couple of days ago from the Swiss National Bank. Figures show that Swiss banks were hit by SFr970 million, or $1.0 billion, in negative interest rate charges in the first six months of this year (source: Reuters). As striking as the absolute figure is the fact that the figure rose 40 per cent year-on-year. Under the current regime, the SNB charges a 0.75 per cent fee on large deposits, a fee introduced in 2015 in a bid to cut the value of the Swiss franc, seen as overvalued and a headache for the country’s exporters.

With wealthy clients keeping over a fifth of their wealth (source: Reuters) in cash, it is easy to see why negative rates are a drag on banks’ earnings. And on top of the regulatory and other forces squeezing banks in countries such as Switzerland, it explains why consolidation continues. The SNB, for example, noted recently that in 2016, 226 of the 261 banks in Switzerland reported a profit, taking total profit to SFr11.8 billion, while the remaining 35 institutions recorded an aggregate loss of SFr3.9 billion. At the turn of the century there were well over 300 banks; that number has eroded considerably. 

One suspects the pain of negative rates in Switzerland and elsewhere is not going to end very soon. 

 

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