The dangers of plunging into negative interest

The dangers of plunging into negative interest
 Simon Dawson/Bloomberg

We have heard an unprecedented use of the word ‘unprecedented’ over the past nine months. There may, unfortunately, be more yet to come.

We are increasingly hearing talk of the possibility of negative interest rates.

What does that actually mean? If you lend someone your money, which is what a deposit is, they pay you for using your money for that period - the interest rate. If it is negative, you would have to pay them.

Low interest rates are lousy for savers and pensioners. Negative rates would be awful.

An extraordinary example of the absurdities negative interests generate can be found in Switzerland.

Apparently, in some Swiss cantons citizens are fined if they pay their local taxes before the due date. Why? Because it would cost the canton to hold the taxpayers’ money received before the due date.

Ah – but for borrowers, lower rates are better. So would negative rates further punish savers and reward borrowers? Not quite. Probably both would suffer. And in more ways than one. Banks and building societies traditionally benefit from the gap between the value of holding your money and the interest rate that they pay you for it.

Your current account may already pay nothing; deposit account rates are now very low. But if rates were negative then that gap, from which the bank or building society benefits, would disappear. Indeed the gap would probably become negative, a cost, assuming that they did not actually charge you for holding your money but rather just paid zero interest. 

A nightmare scenario for bankers, politicians and the police, to a degree, would be the withdrawal of cash if banks started charging for holding your money. You would withdraw it and hide it under the mattress for free.

No one has much sympathy for banks, but they need to make a reasonable return on the shareholders’ capital they hold in order to operate.

Building societies need to make a return on the capital they hold on behalf of their members in order to be able to grow. In a world of negative rates, that becomes much harder.

There would really be no choice for banks and building societies. They would simply need more revenue and/or less costs. Three things would be likely to happen.

First, the end of free, in credit, current accounts. We would have to pay for them and we may well have to pay for money transmission services, which currently are mostly free. 

Second, the cost of borrowing money would go up. Mortgage rates are very competitive at the moment and they would probably rise. In continental Europe, where some countries have had negative rates, this has been the experience. The cost of other forms of debt would be likely to rise too.