The negative interest rates imposed by the Bank of Japan have begun to make their way into the Japanese banking system. Japanese trust banks have begun to impose negative interest rates on accounts held by institutional investors. It shouldn’t be surprising that Japanese banks are trying to pass on the costs imposed by the central bank’s policy of negative interest rates. It happened in Switzerland, it is happening in Japan, and it will happen in Europe. And as it becomes more widespread, investors will begun to withdraw their funds from the banking system.
Remember back in December when we highlighted that one of the responses to central banks’ introduction of negative interest rates might actually be a raising of interest rates by banks to borrowers?
The bank’s preferred solution then might be to keep income up by widening the spread between deposit rates and borrowing rates by increasing the interest rate charged to borrowers. And thus dropping into negative interest rates on deposits can lead to a rise in interest rates for borrowers.
Well, that apparently is happening in Switzerland, whose central bank has had negative interest rates for over a year.
In response, it seems, Swiss banks have pushed up the cost of mortgages, particularly long-dated ones, with spreads more than doubling on average, according to Brupbacker and Nemes. At the same time, the lower bound on retail deposits has been maintained, for the obvious reason of not wanting to incentivise customers to turn up at branches and demand their cash.
It seems that borrowers are trying to lock in lower interest rates by taking out longer-term loans, causing banks to raise the interest rates on those loans so as to maintain or widen the spread between rates charged to borrowers and offered to depositors. Longer-term loans, of course, brings up other problems with maturity mismatching (loans that are ultra-long-term, backed by deposits which can be withdrawn immediately), but that’s a problem inherent to loan banking anyway. For now, the move to negative interest rates appears to be spurring borrowing (or maybe just refinancing) but at a higher cost than central banks would have predicted.
Carl Menger Center President Paul-Martin Foss was interviewed this weekend by Jeff Deist, President of the Ludwig von Mises Institute, on the topic of negative interest rates.
By Joseph T. Salerno
In 2016, the Fed’s annual stress test on banks will include a scenario in which the interest rate on the three-month U.S. Treasury bill becomes negative in the second quarter of 2016 and then declines to -0.5%, remaining at that level until the first quarter of 2019. According to the Fed, “The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities.” In other words, including this scenario in its stress test is not supposed to signal that the Fed is contemplating adopting a deliberate policy of negative interest rates. It is simply testing the resilience of big banks in the face of a severe recession that precipitates a “flight to safety” which spontaneously drives rates on short-term Treasury securities into negative territory. Or so they would have us believe.
On Friday, New York Fed President William Dudley acknowledged that negative interest rates are a potential policy tool that the Federal Reserve might decide to implement. Although he did apparently state that the Fed is not seriously considering introducing negative interest rates right now, Dudley’s answer still should give us pause. There are a few things that should be kept in mind regarding Dudley’s response and any further discussion among Fed officials about negative interest rates.
The European Central Bank (ECB) made waves recently with its decision to lower interest rates on its deposit facility to -0.30%. That means that banks wanting to park their money at the ECB have to pay the ECB for that privilege. The supposed reason for introducing negative interest rates is to spur lending on the part of banks. Rather than being able to park their money at the ECB for free or for a small guaranteed return, the ECB wants banks to put that money to use by lending it. The idea of negative interest rates was once seen as impossible to achieve by many central bankers. But since the ECB’s decision last year to introduce negative interest rates, the concept has become increasingly accepted among central bankers, with even a few Federal Reserve officials supporting the idea of negative rates. But are negative interest rates really feasible?