Buzz
What if a bank’s interest rates were so low that they actually charged you for keeping your money there? What if you could borrow money without paying any interest at all? That’s the concept behind negative interest rates. It’s a relatively new and unusual idea that’s been making headlines recently. Here’s a brief explanation of what negative interest rates are and what we can expect from them.
The Purpose Behind Negative Interest Rates
The main objective of negative interest rates is to motivate people to spend more, save less, and take out loans.
When an economy slows down and people aren’t spending, a country’s central bank (such as the Federal Reserve in the United States) may reduce interest rates to boost spending. The idea is that lower rates make people more inclined to borrow money, including loans and mortgages, which injects more funds into the economy. At the same time, the lack of incentives to save discourages hoarding money.
The reality is, central banks globally have already reduced their interest rates to zero, yet this hasn’t been enough to revitalize their economies, which remain sluggish. Their response? Negative interest rates.
In February, Japan dropped interest rates to -0.1 percent, followed by a recent cut to -0.4 percent by the European Central Bank. Five of the world’s leading central banks—the European Central Bank, the Bank of Japan, Denmark’s National Bank, Swiss National Bank, and Sweden’s Riksbank—now have negative interest rates. When economies enter negative territory, here’s what occurs, according to Investopedia:
A negative interest rate means that central banks—and potentially private banks—will charge negative interest: rather than earning money on deposits, account holders must pay fees to store their money. The goal is to encourage banks to lend more freely, and to motivate both businesses and individuals to invest, lend, and spend rather than pay to keep their money in a safe place.
In essence, banks are now being charged to hold onto funds, and some may pass this cost onto customers. According to the BBC, this is already happening, mainly affecting businesses with large account balances. At a minimum, consumers won’t earn anything for saving money in their accounts. However, on the other side, people could potentially take out loans without paying any interest. The New York Times explains it like this:
The longer you take to repay a negative-interest-rate mortgage, the less you owe, even if you don’t pay anything. Essentially, negative rates can make saving money seem unwise, while borrowing can become incredibly appealing.
Overall, introducing negative interest rates is quite an unconventional step. The outcomes remain uncertain, but there are certainly some worries.
The Impact on Banks
One of the main concerns is the “mattress effect”: customers may pull their cash out and hide it under a figurative mattress. Why leave it in a savings account earning nothing? If everyone withdraws their money, banks will have nothing to lend. http://fortune.com/2016/02/23/jap…
Furthermore, banks generate income by charging interest on loans. If rates are at zero, they aren’t making any money. Combine this issue with the lack of funds to lend, and there’s a real fear that negative interest rates could eventually lead to the downfall of banks. And that’s a problem, because it usually causes a serious disruption to the economy.
As CNBC highlights, however, the situation isn’t as dire as it might seem. Central banks are aware of these risks and actively work to minimize them:
For instance, the Bank of Japan’s negative interest rate policy applies to only around 10 percent of commercial bank reserves at the central bank, with the rest of the reserves either earning zero or slightly positive interest. This “tiered” system is meant to minimize the effect of negative rates on banks’ profitability. The European Central Bank, which is expected to further relax its monetary policy in March, might consider implementing a similar strategy…
They highlight Switzerland and Sweden as proof that negative interest rates could be beneficial. According to CNBC, bank lending in these countries is growing more rapidly than in the Eurozone, despite having significantly lower rates.
Negative Interest Rates in the U.S.
Although Federal Reserve Chair Janet Yellen has mentioned that negative interest rates might be “on the table”, it’s unlikely we’ll see them anytime soon. For one, the Fed recently raised interest rates. Moreover, it would take quite a few things going wrong before negative interest rates are considered, and for now, the economy is in decent shape. As Forbes explains:
...despite recent volatility and struggles in the stock and commodities markets, the U.S. economy isn’t in terrible shape. The labor market remains strong, and consumer spending is resilient. As a result, the U.S. is far from requiring another round of monetary policy easing, especially not through negative interest rates.
It’s still too early to assess whether negative interest rates are having a positive effect on other economies. Economists are divided—some argue they’re a bad move, while others claim they’re already producing results. At this stage, only time will tell.
Illustration: Fruzsina Kuhári.
