• John Adams

The Ugly Impacts of Negative Nominal Interest Rates

Updated: Apr 16

An evolving story in 2019 which will become more transparent in 2020 and 2021 is how negative nominal interest rates (NNIRs) operate, what their full impacts are and whether this is virtuous and sound public policy or not.


As noted in my earlier 2019 article entitled, ‘The New Global Push for Negative Nominal Interest Rates’[1], there is a centralised global push by international economic institutions such as the International Monetary Fund, major central banks and particular academic economic circles who are pushing for deep NNIRs to become the policy of choice to respond to the slowing global economy and to any coming economic recession.


The effects and implications of NNIRs have become more evident in 2019.


How do NNIRs work?

From a technical perspective, NNIRs are a deliberate official policy rate which is imposed by the central bank on the reserves deposited by Authorised Deposit-taking Institutions (ADIs)[2] at the central bank.


Typically, central banks have discretion, subject to any legal and political constraints, to determine the policy rate and what percentage of ADIs reserves will the policy rate be charged on them as most central banks operate as institutions independent from the executive national government.


As noted by the Governor of the Reserve Bank of Australia (RBA), Dr Philip Lowe in a recent 26 November 2019 speech on unconventional monetary policy[3], in the case of Japan, a negative nominal interest rate of -0.1% applies to “only a very small share of bank reserves at the Bank of Japan”[4]. Alternatively, in the European context, NNIRs have been applied to the majority of ADI bank reserves, although such application has operated on a ‘tiered basis’ (see discussion below).


Once NNIRs are applied by the central bank, the commercial burden of dealing with these nominal losses on capital reserves rests with the ADIs themselves. Multiple options exist as to how ADIs will offset these losses including:

  • reducing internal ADI operational costs;

  • raising offsetting revenue by imposing additional fees on ADI customers either on a service or product basis (customers may include either retail or wholesale clients);

  • raising offsetting revenue by raising interest rates on particular lending products[5];

  • imposing NNIRs on customer funds deposited into the ADI (customers may include either retail (individual or business) or wholesale clients); or

  • accepting lower profits resulting in lower rates of returns for shareholders and/or members.


Diagram 1 provides a pictorially illustration of how negative nominal interest rates work.


Diagram 1: How Negative Nominal Interest Rates Operate

















How have NNIRs applied in Europe and Japan?

Multiple jurisdictions have to date implemented NNIRs as an official policy tool including the:

  • European Central Bank (ECB);

  • Bank of Japan (BOJ) (i.e. the central bank of Japan);

  • Danmarks Nationalbank (DN) (i.e. the central bank of Denmark);

  • Swiss National Bank (SNB) (i.e. the central bank of Switzerland); and

  • Riksbanken (i.e. the central bank of Sweden)[6].


Important to note that across these jurisdictions, the application of NNIRs have differed in terms of:

  • the policy purpose by the respective central bank; and

  • how individual ADIs have sought to offset the costs of NNIRs in response to official negative policy rates.


In terms of the former, the SNB, for example, have implemented an official -0.75% negative policy cash rate on ADI reserves above 20x of minimum capital reserves[7] in order to reduce the appreciation pressure of the Swiss Franc which has been surging as a result of strong capital inflows from across Europe[8]. In this instance, NNIRs were tied to a minimum conversion rate with the Euro.


Alternatively, the ECB has sought to implement NNIRs in order to provide monetary stimulus through applying downward pressure on short-term market interest rates.


In terms of the latter, various ADIs across Europe and Japan have responded to the imposition of NNIRs in very different manners[9], including:


Denmark

  • starting 1 December 2019, Jyske Bank (the 2nd largest lender in Denmark) imposed a -0.6% interest rate for individual clients who deposit more than 7.5 million Danish kroner (1 million euros or £916,000)[10]. Although, NNIRs were first introduced on business accounts under broad terms in 2016[11].


Germany

  • Volksbank Raiffeisenbank Fürstenfeldbruck (VRF)[12] (in Northern Bavaria, Germany) started charging a NNIR of -0.5% on deposits as little as 1 euro, a revision to the previous rule which stated that adverse interest rates would only affect deposits above 100,000 euros. The new ruling affected all money market accounts that were created since 1 October 2019.


Switzerland


The Consequences of NNIRs

There are several consequences of NNIRs which have emerged with its current application that have been called out by several institutions such as the Bank for International Settlements (BIS).


According to an October 2019 BIS Committee on the Global Financial System (CGFS) research paper entitled, “Unconventional monetary policy tools: a cross country analysis”[14], the imposition of NNIRs have produced several observable results. This includes NNIRs:

  • operating through the conventional transaction mechanism similar to how positive official interest rates work thus pushing down short-term rates beyond the zero or effective lower bound;

  • adjusting long term yields in line with expectations resulting from lower short-term yields thus creating a short-run economic stimulatory impact. This impact has been enhanced for both short‑term and long-term interest rates when combined with other forms of unconventional monetary policy including QE as in the case of Japan;

  • producing compressed spreads between deposit rates and lending rates for banks thus resulting in compressed net interest margins;

  • producing ‘containable and manageable’ side-effects impacting on financial stability, although the BIS suggests that these side-effects may become more severe if NNIRs remain in place for a longer period; and

  • forcing central banks to introduce particular exemptions on the quantum or type of reserves that are subject to NNIRs to offset the impact on bank deposits (i.e. a tiering system).


Moreover, according to November 2019 research from the Centre for Economic Policy Research[15], NNIRs under the ECB found that:

  • European ADIs were able to transfer negative rates onto deposits with the ability to transfer dependent as to how sound the banks are[16] (the more sound - the greater ability);

  • the quantum of deposits increased over the period reflecting higher demand for liquidity and safe assets (a 0% rate was only a constraint if confidence in an individual ADI was shaky); and

  • European corporate clients are more exposed than individual or household clients resulting in corporate clients shifting funds from short-term assets and cash to fixed income investments.


Nevertheless, NNIRs has invited sharp criticism from outside of central bank officials and academic economists including from the world’s largest bond fund, PIMCO (Pacific Investment Management Company). According to PIMCO, NNIRs have produced counter-productive economic effects[17] given that they:

  • squeeze bank profits thereby reducing the willingness of banks to lend to individuals and businesses[18];

  • depress market returns on bank shares[19] and thus create significant challenges for pension funds and insurers that offer guaranteed payouts; and

  • create ‘money illusion’ thus making savers feel poorer which results in cuts to consumption.


With specific reference to Sweden who had a regime of NNIRs from 2009 to 2019, detractors of NNIRs point to the fact that this policy has been to inflate assets prices or non-replicable assets such as:

  • boosting the real estate index by 50%;

  • increasing non-replicable assets (such as infrastructure) between 30% - 50%; and

  • boosting the Swedish stock market by more than 20%.


However, Swedish household consumption and investment (gross capital formation) have increased very little and real wages have remained stagnant[20].


Impact on Cash Hoarding

Interestingly, a debate has emerged as to whether NNIRs increase physical cash hoarding among institutions and individuals or not given that physical cash yields a 0% nominal interest rate and thus is commercially more attractive than holding funds within an ADI.


Early evidence from Japan in 2016 suggested that NNIRs had a significant impact on cash hoarding outside of the banking system by Japanese Households as measured by the monthly sales of steel fire‑proof safes. According to analysis by Deutsche Bank, a surge in monthly sales of safes in Japan occurred from the point at which NNIRs were introduced to reach the highest level of monthly safe sales at any point since the Global Financial Crisis[21].


Moreover, further 2016 anecdotal evidence suggested that corporations in Switzerland who were exposed to NNIRs were hoarding significant quantities of physical Swiss franc bank notes and taking out insurance policies which would protect their physical cash from theft or damage[22].


However, according to the RBA Governor’s 26 November 2019 speech, NNIRs have had a limited impact on cash hoarding by stating:


“While countries with negative interest rates have seen some shift to banknotes, it has been on a limited scale only. This reflects the use of bank deposits for making transactions and the fact that most banks in countries with negative interest rates have set a floor of zero on retail deposit rates. These banks have judged that it doesn't make sense, either commercially or politically, to charge households and small businesses negative interest rates on their deposits.”


However, this view is not universally shared. In response to allegations that over $US 1.5 trillion of $US 100 bills have gone missing (as reported by the Wall Street Journal)[23], the US Treasury Secretary Steve Mnuchin stated in a recent 22 December 2019 Fox Business interview that:


It is interesting, the dollar is the reserve currency of the world and everyone wants to hold dollars. And the reason why they want to hold dollars is because the US is a safe place to have your money, to invest and to hold your assets in US dollars. It is interesting because in the world where everything is going digital and in electronic payments, the demand for US currency continues to go up. Literally, a lot of these $100 bills are sitting in bank vaults all over the world and particularly in a world of negative interest rates, you can hold US dollars and you don’t have to lose money. So there are a lot of Benjamins’ all over the world[24]


Thus, anecdotal Japanese, Swiss and American examples suggest that cash hoarding may be more prevalent in response to NNIRs relative to what the RBA Governor suggested.


This point is important in the Australian context given the Morrison Government’s attempt to introduce a $10,000 cash transaction ban via the Currency (Restrictions on the Use of Cash) Bill 2019 which is currently before the Australian Senate.


NNIRs in Australia

With respect to Australia, in light of the debate over a $10,000 cash transaction ban and a slowing domestic economy, there continues to be speculation as to whether NNIRs will become a tool of official policy in Australia, especially in the event of a global economic shock.


Given this speculation and the adverse observable consequences of NNIRs, the RBA Governor, as noted in his recent 26 November 2019 speech (see above), indicated that:

  • the implementation of NNIRs in Australia as an official policy tool is ‘extraordinarily unlikely’; and

  • the RBA’s preferred model for unconventional monetary policy is implementing quantitative easing via purchasing government bonds once official policy rates hit 0.25%.


Nevertheless, the RBA Governor during the subsequent question and answer session following his speech stated that:


“but if the unemployment rate was rising materially and inflation was moving away from target, then all options would need to be on table”,


meaning that unconventional monetary policy beyond the RBA’s preferred model (which includes NNIRs) would be considered and potentially implemented.


Importantly and despite the official comments of the RBA Governor, it would appear that Australia’s commercial banking and trading exchange industries are currently implementing precautionary strategies and initiatives to prepare for an environment of NNIRs in Australia.


This includes, for example:

  • the Australian Stock Exchange (ASX), who in mid-2019 implemented new information technology systems which allows for trading of negative yielding financial instruments[25]; and

  • Australia’s big four banks (i.e. Westpac, CBA, NAB and ANZ) who, in recent testimony to the Federal Parliament’s House of Representatives Standing Committee on Economics, stated that they have conducted high levels analysis testing to determine whether their organisation’s information technology systems can operate under an official policy environment of NNIRs[26].


These initiatives demonstrate that the probability of an introduction of NNIRs in Australia in 2020 or beyond may be higher than what has been recently suggested by the RBA Governor thus Australian corporations and individuals need to be attuned to potential NNIRs consequences well in advance.


Conclusion

The implementation of NNIRs has been a grand economic experiment which has been tested as an official policy tool only in recent years in the post-GFC period mainly in the European theatre. European policy makers in particular, have been forced into implementing NNIRs on a desperate monetary stimulus policy initiative given:

  • a stagnating European economy with multiple and consecutive years of sub-par economic growth; coupled with

  • the greatest global debt bubble in human history which according to the International Institute for Finance has reached as of June 2019 to be in excess of $US 250 trillion.


Available economic analysis suggests that the effects of NNIR may be counterproductive, although it is important to note that the full ramifications of NNIRs are yet to be determined given that:

  • the NNIR experiment is still ongoing; and

  • deeper NNIRs may become a feature of official public policy around the world if the global economy stagnates further in 2020 and potentially enters a technical economic recession in either late 2020 or 2021.


Nevertheless, all economic agents whether they be individuals, households or corporations need to remain vigilant as to the effects of NNIRs given that they are a wealth distribution mechanism to the existing top 1% financial power structure and there remains a global push to install deep NNIRs in the next economic crisis.


John Adams is the Chief Economist for As Good As Gold Australia

[1] https://www.adamseconomics.com/post/the-new-global-push-for-negative-nominal-interest-rates


[2] Internationally, ADIs mainly refers to commercial banks, however, in the Australian context this also includes

other types of institutions including Credit Unions and Building Societies.


[3] https://rba.gov.au/speeches/2019/sp-gov-2019-11-26.html


[4] NNIRs were introduced in Japan in 2016.


[5] Evidence of this has been seen in Switzerland, however, mortgage rates came back down over time as a result of competition, particularly from the non-bank sector – See Footnote 20 of Bank for International Settlements (2019), Paper No. 63 of the Committee on the Global Financial System “Unconventional monetary policy tools: a cross-country analysis”, see link: https://www.bis.org/publ/cgfs63.pdf.


[6] Note that the Riskbaken was the first European central bank to first charge commercial banks to hold deposits in 2009. In 2015, the Riskbaken pushed their official policy rate lower than zero following a similar move from the European Central Bank. However, in December 2019, the Risksbaken announced that it was going to abandon NNRIs (on repurchase agreements), but continue other forms of unconventional monetary policy - https://www.zerohedge.com/economics/negative-rates-destruction-money-sweden-ends-its-experiment.


[7] https://www.independent.co.uk/news/world/europe/switzerland-swiss-banks-negative-interest-rates-hoarding-cash-a7235816.html


[8] The initial SNB policy rate was -0.25% in December 2014, but then subsequently shifted to -0.75 %.


[9] Note that according to the Bank for International Settlements (see footnote 14 below), the impact of NNIRs on ADI lending rates and lending volumes is not uniform and is dependent on their business model as well as their funding model (i.e. whether the ADI is funded by deposits or from the credit/wholesale market).


[10] https://www.independent.co.uk/news/world/europe/denmark-bank-negative-interest-rates-millionaires-charge-a9074756.html


[11] https://www.thelocal.dk/20190820/millionaires-to-be-hit-by-negative-interest-rate-at-danish-bank


[12] https://www.tronweekly.com/german-banks-begin-introducing-negative-interest-rates-as-holders-contemplate-turning-to-bitcoin/


[13] https://www.theguardian.com/business/2019/aug/06/raking-it-in-ubs-to-start-charging-super-rich-clients-for-cash-deposits


[14] Bank for International Settlements (2019), Paper No. 63 of the Committee on the Global Financial System “Unconventional monetary policy tools: a cross-country analysis”, see link: https://www.bis.org/publ/cgfs63.pdf


[15] This research was published by multiple contributors including officials from the ECB. See the following link: https://voxeu.org/article/impact-negative-interest-rates-banks-and-firms


[16] Under ECB NNIRs, approximately 5% of total deposits and 20% of corporate deposits in the euro zone became negative; whereas approximately 15% of total deposits and 50% of corporate deposits in Germany became negative.


[17] https://www.bloomberg.com/news/articles/2019-12-03/pimco-joins-chorus-of-negative-rate-detractors-as-backlash-grows


[18] As reported by CNN International, NNIRs have had a significant material adverse impact on Deutsche Bank which has magnified the bank’s existing financial problems. See following link: https://edition.cnn.com/2019/07/29/business/deutsche-bank-ecb-negative-rates/index.html


[19] The Euro Stoxx Bank Index (Bank shares that are prices in Euros) which is a basket of eurozone lenders is down by more than 40% since the ECB introduced NNIRs. See following link: https://edition.cnn.com/2019/07/29/business/deutsche-bank-ecb-negative-rates/index.html


[20] https://www.zerohedge.com/economics/negative-rates-destruction-money-sweden-ends-its-experiment


[21] https://fortune.com/2016/06/01/negative-rates-safes/


[22] https://www.independent.co.uk/news/world/europe/switzerland-swiss-banks-negative-interest-rates-hoarding-cash-a7235816.html


[23] https://www.wsj.com/articles/the-worlds-cash-is-disappearing-bankers-arent-sure-where-it-went-11576184491


[24] https://www.zerohedge.com/markets/steven-mnuchin-explains-why-15-trillion-100-bills-have-disappeared


[25] https://www.bloomberg.com/news/articles/2019-07-15/australia-s-asx-prepares-for-negative-interest-rate-trading


[26] The Chief Executive Officers (CEOs) of CBA and Westpac testified to the House of Representatives Standing Committee on Economics in Canberra regarding an inquiry into the Big 4 banks on Friday, 8 November 2019, whereas the CEOs of NAB and ANZ testified to the same committee on Friday, 15 November 2019.

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