The plunge to sub-zero: how does Temenos support zero and negative interest rates?

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1 The plunge to sub-zero: how does Temenos support zero and negative interest rates?

2 Contents 1 - Executive Summary Background Interbank lending rate Negative base rate and zero base rate How does negative interest affect bank customers? How does negative interest rate impact banking software? Adoption of negative interest rate Scope Major features Current coverage for zero and negative interest Core Banking Other product families

3 1 - Executive summary Interest rate is at the lowest it has ever been globally and some banks have even already moved into the negative interest territory. Negative interest rates have been around for over 25 years, since Japan implemented it in the 90s. However, it is now becoming a more widely spread monetary policy measure used by central banks to boost the country s economy. This is a massive shift from traditional banking where an interest rate is usually positive. As you would imagine, it is becoming a critical issue in finance and banking software as it impacts the most basic of calculations such as interest accrual and accounting. Additionally, it has raised awareness among the global banking community that rates can actually be negative, and we should therefore anticipate the impending questions on it and prove our ability to support this in our products for both clients and prospects. This will be standard in sales campaigns for the coming few years. A few banks have already implemented the negative interest rate, and given the current economic uncertainty, more banks will be moving into the negative interest territory in the near future. We are seeing this occur in countries where we have lots of clients and there have been a number of questions on the capability of our products to handle this. While Temenos products do provide support, gaps exist in some areas where work is required for the applications that only partially and/or do not support zero and negative interest. Applications that FULLY support negative interest: Product/Sub Family Accounts Core Infrastructure Private Wealth Analytics & Reporting Technology Risk & Compliance Funds Admin Treasury & Capital Markets Applications Accounts Module (AC) and Arrangement Accounts (AR) Position Management (PM) and System Tables (ST) TAP, Data Source, REPO(RP ), Wealth Manager Temenos Analytics Data Framework(DF) ALM, Regulatory Capital, IFRS Temenos Multifonds Swaps(SW) Applications that PARTIALLY supports negative interest: Product/Sub Family Lending and Deposits Treasury and Capital Market Applications AA Deposits and AA Lending (missing only Annuity Calculation) & Loans and Deposits (LD), Provisioning (PV) Money Market, Forex Applications that DO NOT support negative interes Product/Sub Family Lending and Deposits Trade Banking Private Wealth Treasury & Capital Market Applications Syndicated Loans (SL), Mortgage(MG), AZ All in One (AZ) Drawings(LC), Discounted Bills(BL) Bonds(SC), Fiduciary(FD) FRA, Non-Deliverable Forward(ND) The purpose of this paper is to provide an insight of the current coverage for zero and negative interest rate across Temenos solutions. 3

4 2 - Background The negative interest rate, also known as the deposit rate, is what central banks charge commercial banks for excess funds held on deposit. The aim is to stimulate economic growth and to raise inflation, which may also be below zero. Central banks want to encourage commercial banks to lend to businesses rather than hold on to money. In Denmark and Switzerland, the immediate objective has been to prevent the currency rising too much. The idea of lower and negative interest rates is to discourage investors from buying the local currency, which tends to push its value up Interbank lending rate For commercial banks, any excess funds parked at the central bank involve paying the central bank a negative deposit rate. It may be preferable for commercial banks to lend money to another bank or a government bond (even if there is a negative return) rather than pay to keep it at the central bank. That is part of the reason some banks are lending to each other at negative interest rates; hence, some of the rates known as LIBOR (London Interbank Offered Rates), in Euros, Swiss francs and Japanese Yen are down below zero. The EURIBOR (Euro Interbank Offered Rate) is also in negative territory. The Bond market has also been hit by the negative yield in Europe for many years now. Yields on 2-year government bonds are negative in six European countries: Switzerland, Denmark, Germany, the Netherlands, Finland and Austria. The German 10- year Sovereign bonds yield has recently reached its lowest yield Negative base rate and zero base rate As well as implementing the negative deposit rates, some central banks have gone further into the negative interest rate territory by imposing a negative base rate. This is the rate at which commercial banks can borrow or deposit funds for short term. In normal economic circumstances, this base rate will influence all the interest rates set by other banks and financial institutions. Although some central banks may not have gone into negative territory yet, and just stop at a zero base rate, it can still result in negative rates when the margin (if negative) is taken into account for a product How does negative interest affect bank customers? While negative interest rates (deposit rates) are normally aimed at institutional investors, they may have a disadvantageous effect on savers in the long term if investors decide to recover the costs of the rate by levying charges on consumers. Low interest rates are absolutely unwelcome news to savers. A negative base interest rate, on the other hand, will have a direct impact on the bank customers. Commercial banks have been reluctant to pass negative rates to their retail customers, as it may lead to major deposit withdrawals How does negative interest impact banking software? In traditional banking, interest on a bank deposit is usually positive, as a saver is expected to earn interest from the bank. In the same way, a lender is expected to pay interest to the bank. Banking software has been built to do just that. With the introduction of the negative interest rate, however, as a worst-case scenario, this logic may be reversed, where a saver could be paying interest and the lender earning interest. Banking software must be able to cater for this eventuality. Equally, banking software may need to handle negative rates on loans for interbank transactions where the other side is a negative deposit. There are even cases where lending contracts have not catered for zero negative base rates, and as a consequence, the bank is obliged to pay interest on a loan due to the resulting negative rate. The same applies to the bonds market. 1 BBC News. Why use negative interest rates? by Andrew Walker BIS Quarterly Review. How have central banks implemented negative policy rates? by by Morten Linnemann Bech and Aytek Malkhozov A World Bank Group. Global Economic Prospects - The Global Economy in Transition. June

5 2.2 - Adoption of the negative interest rate The adoption of the negative interest rate has already happened globally and is likely to have the greatest impact on banks and other financial institutions within the Eurozone, especially with the current economic crisis and the volatility of the European Market. The graphic below shows the countries that are currently applying a negative interest rate or zero rate: Europe The European Central Bank (ECB) Base/Repo Rate % Deposit Facility Rate % Marginal Lending Rate % Denmark Danmarks National Bank (DN) Base/Repo Rate % Deposit Facility Rate % Marginal Lending Rate % Sweden Sveriges Riksbank Base/Repo Rate % Deposit Facility Rate % Marginal Lending Rate % Germany Deutsche Bundesbank Base/Repo Rate % Deposit Facility Rate % Marginal Lending Rate % Switzerland Swiss National Bank (SNB) Japan Bank of Japan (BoJ) Base/Repo Rate % Deposit Facility Rate % Marginal Lending Rate % Base/Repo Rate % Deposit Facility Rate % Marginal Lending Rate % Base/Repo Rate: Deposit Facility Rate: Marginal lending rate: The base or repo rate is the rate of interest at which banks can borrow or deposit funds from central banks for short term The deposit rate is the rate of interest banks receive when they deposit funds in their accounts at the Central Bank This is the rate of interest banks pay when they borrow overnight funds from the Central Bank Sources:

6 3 - Scope The analysis on the current coverage of zero and negative interest rate has been done across all Temenos product families, and the impact lies mostly within Temenos Core Banking. The section provides more detail on the major features for negative interest rate, the current coverage across Temenos products. It also provides a summary of gaps across Core Banking modules Major features The following is a summary of functional requirements of Temenos software products to support zero and negative interest: The ability to apply a zero base rate or market rate for floating rate contracts The ability to apply a negative interest rate, base rate and market rate for floating rate contracts The ability to capture and hold a zero interest rate at contract for fixed rate contracts The ability to generate accounting for negative interest The ability to view contracts position with negative interest amounts No withholding tax should be charged on deposits if interest rate is negative The ability to apply the correct direction of receipt/payment message with negative interest amount. The ability to capture and hold a negative interest rate at contract for fixed rate contracts The ability to set a floor rate of zero if interest rate is negative The ability to switch on/off the floor rate of 0 The ability to perform an annuity calculation on negative interest The ability to perform interest accrual on negative interest 6

7 3.2 - Current coverage for zero and negative interest This section provides a summary of the current coverage for zero and negative interest rate across the Temenos products that may be impacted. The products are shown under the Core Banking and the other product families Core Banking The table shows the coverage for products under Core Banking. Note: ( Fully supported means there is no gap; Partially Supported means some functionality is there, but there are some gaps; Not supported means that it does not support any of the functionality related to negative interest) Product Sub Family Module Support for zero interest Support for negative interest Availability Accounts Accounts (AC) Fully Supported Fully Supported AA Retail Accounts (AR) Fully Supported Fully Supported Negative rates for Credit Interest have been available prior to G5 Negative rates for Debit Interest have been available since and in R13 Lending & Deposits AA Deposits (AD) AA Lending (AL) Fully Supported Partially Supported Loans and Deposits (LD) Fully Supported Partially Supported Since 2003 Negative rates have been available for AA Deposit products since R09 Negative rates have been available for AA Lending since R12 Mortgage (MG) Fully Supported Not Supported AZ All in One (AZ) Not Supported Not Supported Syndicated Loans (SL) Fully Supported Not Supported Provisioning (PV) Fully Supported Partially Supported Trade Banking Drawings (LC) Not Supported Not Supported Discounted Bills (BL) Not Supported Not Supported Private Wealth Products Data Source Fully Supported Fully Supported Repo (RP) Fully Supported Fully supported Since 2002 Bonds (SC) Fully Supported Not Supported Fiduciary (FD) Not Supported Not Supported FRA Not Supported Not Supported Treasury and Capital Markets Money Market Fully Supported Partially Supported Since R9 Swaps Fully Supported Fully Supported Forex Fully Supported Partially Supported Non-Deliverable Forward(ND) Fully Supported 7 Not Supported

8 Other product families The table below shows the modules within other Temenos product families that may be impacted by zero and negative interest rate: Product Family Products Comments Core Banking Infrastructure Position Management (PM) System Tables (ST) Can handle Negative interest amounts and has the ability to define a zero and negative base rate (BASIC.INTEREST) Have the ability to define a zero and negative market interest rate (PERIODIC.INTEREST) Analytics Technology Risk & Compliance Funds Admin Front Office Analytics Data Framework (DF) Asset & Liability Management Regulatory Capital IFRS Multifonds TAP (Wealth Suite, Front Office, Portfolio Management) Analytics can handle negative interest rates and amounts from the data it receives from Core Banking Data Framework can take data with negative interest rates and negative interest amounts Already supports negative interest IFRS supports EIR and NPV calculation based on negative interest rates and interest amounts No impact, can support negative interest rate and interest amount Fully supports negative interest 8

9 About Tememos Temenos Group AG (SIX: TEMN), headquartered in Geneva, is a market leading software provider, partnering with banks and other financial institutions to transform their businesses and stay ahead of a changing marketplace. Over 2,000 firms across the globe, including 38 of the top 50 banks, rely on Temenos to process the daily transactions of more than 500 million banking customers. Temenos customers are proven to be more profitable than their peers: in the period , they enjoyed on average a 31% higher return on assets, a 36% higher return on equity and an 8.6 percentage point lower cost/income ratio than banks running legacy applications. Learn more To find out how Temenos can help you, then contact sales@temenos.com or visit us at 9

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