Can banks survive negative rates?

The declining economic outlook and increasing political pressure are pushing central banks into more aggressive unconventional monetary policies. Simultaneously, fears are growing that such steps, especially negative interest rates, actually threaten the stability of the financial system. They risk setting off dangerous feedback loops in credit markets and the real economy, where the second and third-order effects are difficult to anticipate or control.
Low growth, low inflation, output gaps, unemployment and underemployment first prompt central banks to lower rates below the zero bound. The objective is to stimulate borrowing to finance consumption and investment, thus setting off a self-sustaining growth cycle.
Regulations require banks to maintain customer deposit bases. The fear of losing customers dissuades those banks from cutting deposit rates. In Europe, only large corporations have faced negative rates, which means they’re charged to maintain deposits.
As interest rate margins contract and profits are squeezed, banks raise fees or turn to other revenue measures to boost earnings. This keeps actual borrowing costs relatively high, undercutting the whole point of a negative rate policy.
As the economy continues to sputter, policymakers slash rates more and more deeply. Government bond yields grow increasingly negative and the yield curve flattens. Banks, which hold substantial amounts of government debt, see their profits decline even further.
Slowing growth increases the number of non-performing loans. This further erodes bank profits and reduces lending. It also increases borrowing costs for banks, which results in higher credit margins for borrowers.
Struggling banks also naturally have less demand for government bonds, which restricts the ability of countries to finance their activities. In extreme cases, where banks need help to stay afloat, already heavily indebted governments must borrow to recapitalise them or guarantee deposits.
There are two primary transmission channels for negative rates between countries. As witnessed in Europe and Japan, banks faced with negative rates export capital aggressively, driving down returns elsewhere. Germany is examining whether to prevent banks from charging most retail clients for deposits. Other alternatives include creating special safe assets or savings accounts that guarantee positive rates. Both measures would undermine negative-rate policies.
The unpalatable reality is that the world still hasn’t learned the true lesson of 2008: An economic model that’s dependent on consumption and investment fuelled by excessive borrowing is unsustainable. Lower rates, which are ineffective and weaken the financial system and ultimately the real economy, are merely a mechanism to maintain excessive debt levels for a little longer.

—Bloomberg

Satyajit Das is a former banker, whom Bloomberg named one of the world’s 50 most influential financial figures in 2014. His latest book is “A Banquet of Consequences” (published in North America and India as “The Age of Stagnation”). He is also the author of “Extreme Money” and “Traders, Guns & Money”