What Would Negative Interest Rates Mean For Borrowers And Savers?
Harry Scheule, Professor, Finance, UTS Business School, Sydney University of Technology.
A number is brewing in the corridors of financial power. The Reserve Bank of New Zealand (RBNZ) recently advised commercial banks that the official cash rate could go from barely positive to negative.
At the moment, the RBNZ is holding back such a step in favor of other monetary incentives Dimensions. But the big banks strongly reject negative interest rates on the grounds that they have had limited success overseas and that the country’s banking technology is incapable of doing so.
However, it remains an option for the central bank to boost spending, investment and employment as part of the COVID-19 recovery. The theory goes that by reducing the cost of borrowing, economic activity picks up.
Those turning to unconventional monetary policy include Japan, Switzerland and the European Union. Negative rates are enough from –0.1% to –0.8% for selected levels of central bank deposits.
In the past, changes in the cash rate have affected changes in loan and deposit rates. For example a 25-Base point A decrease in the cash rate can result in an annual interest savings of $ 2,500 on a $ 1 million loan.
However, given the current low interest rates, these changes will no longer be passed on, which significantly limits the powers of the RBNZ.
Yes, the bank pays you for the loan
It may sound crazy, but if the loan rate is negative and you borrow an amount on interest terms only, the bank will actually pay you interest every time period. For example, Jyske Bank is in Denmark Offer negative interest payments by effectively shortening the repayment period.
Banks should be comfortable offering negative interest rates to borrowers when the banks themselves have savings and other finance at lower interest rates.
But that’s the problem: why should savers pay banks to take deposits? First, instead of paying a bank, they can keep their investments in cash at zero interest rates. Second, they can invest in riskier assets with positive interest rates.
For this reason, only very large depositors (with limited ability to store cash) tend to leave their money with banks with negative interest rates, while regular depositors receive an interest rate of zero or more.
But do negative interest rates work?
The era of monetary policy as a tool to stimulate economic investment and activity has probably come to an end. Negative interest rates do not necessarily lead to productive investment and growth.
Countries that have turned negative have not achieved the expected increases in spending and investment. In addition, the difficulty of passing negative interest rates on to depositors results in loan and deposit rates no longer following the spot rate.
This is also evident in Australia, where the cash rate fell from 0.25% to 0.1% not been passed on to mortgage borrowers except in remote areas such as fixed rate loans.
The graph below compares the average floating rate on mortgages to the New Zealand rate, with the gap widening over time. Charts for Australia and other developed countries would be comparable.
The Reserve Bank of Australia (RBA) has recommended it to borrowers Switch lenders if they don’t pass on rate cuts. However, there is little that central banks can do to address a systemic problem.
What are the risks?
Negative interest rates are likely not the right answer to current COVID shocks. Instead of leading to higher spending, we tend to see the opposite – save more.
In the long run, however, depositors will seek higher returns and shift their funds to riskier asset classes, including the real estate markets, which will drive prices up and reduce affordability for new buyers.
Most economists agree that inflation is not a problem at the moment. But what is medium term? When interest rates rise again, heavily indebted mortgages can be difficult to service.
Read more: Explain: Why the government can’t reduce its pandemic debt with just more money
In either case, negative interest rates are not a long-term solution to current economic challenges. We have to find ways to make the economy more flexible and require fewer rescue measures.
The fragility of supply chains and the still limited movement of workers, goods and services should be a priority. New technologies can become key – innovations that make it possible to work from home and organize activities online have already saved entire industries.
The banking system itself must also be reformed. Banks assume shocks happen once in a thousand years – but we’ve seen two in the past 13 years!
After the global financial crisis in 2008, safety buffers were set up in the financial systems. For example, banks’ capital requirements have been set high in order to be reduced in times of economic downturn. Now is the time to shut them down instead of insisting that they be serviced?
Beyond reaching negative interest rates, the need to rethink economic foundations and create systems that are more resilient to global shocks should be the enduring lesson of COVID-19.
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