Banking is a business and for generations the retail banking system has thrived on a profit model where they hold, sell and lend money for a percentage or a return. Like most businesses, the banking sector has always competed for customers with various monetary incentives like interest free checking, cash bonuses, and other perks to help win new clientele. So there’s no doubt that charging customers interest instead of paying it out would clearly drive depositors away. And while this seems counter-intuitive to all that we know, it is precisely what could transpire if commercial banks pass the burden of negative rates onto consumers.
Several of the world’s national and reserve banks have cut key interest rates below zero and depositors including commercial banks and investors are now paying to place and keep money on account. The theory behind this unconventional policy is to encourage lending by making saving less attractive and borrowing more enticing. The other hope is that negative rates will drive more investment to stocks, real estate and/or technology as financial institutions scavenge for positive returns. In essence, negative rates encourage risk taking with the hopes of stimulating economic growth, but do they work?
The short answer is that no one really knows. Cutting interest rates has been a fairly standard central bank policy for sluggish economies and countries experiencing dangerously low inflation. Lower interest rates are a boon for consumers looking to buy cars and houses and for businesses looking to finance growth and expansion. When nominal rates enter negative territory, however, the world is wading into unchartered waters.
As a form of stimulus, negative rates are less about using “the right tool at the right time” than the only one left in the tool bag. For countries struggling with inflation at unsustainabe low levels and nominal rates already at zero, few options remain. In 2009, Sweden’s Riksbank was the first central bank to utilize negative rates. The European Central Bank, Danish National Bank, Swiss National Bank, Bank of Japan, and most recently the National Bank of Hungary have all followed suit.
