Negative interest rates: outcomes and consequences Pavel Štěpánek Eva Zamrazilová Czech Banking Association Fiscal and monetary policy: between Scylla and Charybdis? Prague, May 20, 2016
Presentation framework Low inflation remains of essential value In this presentation, we do not argue against policies aimed at avoiding any deflation Regardless of present challenges, faced by monetary authorities, inflation targeting has no superior alternative Supporting economic growth is a justified course of monetary policy action if /when inflation is not an issue and if/when monetary policy independence is not put at risk As any other economic policy, through its specific transmission channels, monetary policy has a structured/redistributive effect on various economic agents this presentation mostly addresses the impact on banks
Monetary policy rates Negative policy rates have been introduced in countries accounting for one quarter of global GDP
Negative interest rates arguments of proponents Macroeconomic effects: Negative policy rates can be perceived as necessary means in trying to raise inflation outlooks and counter currency appreciation. Negative rates contributes in re-establishing economic growth. Impact on customers, markets and banks: Some customers may benefit from lower mortgage and wholesale rates and on loans indexed to interbank rates. Banks have had capital gains on securities holdings. Some banks have had a (temporary?) increase in trading and mortgage refinancing activity. Lower funding costs. Lower impairments and non-performing loans until now?
Negative interest rates arguments of opponents Macroeconomic impacts: A prolonged period of low or negative interest rates can itself lead to an expectation of persistent low rates resulting in economic stagnation. Low interest rates may paradoxically increase savings and weaken consumption. Future pensioners in ageing societies may worry more about their retirement and make precautionary savings. Negative deposit rates works as a tax on saving. Distorted asset prices, risk of asset price bubbles, e.g. bonds and equities, real estate. Low/negative interest rates reduce motivations for necessary efforts to consolidate/reform public finance Impact on banks: Negative impact on bank profitability, boosting capital in order to maintain credit expansion and to meet new regulatory capital requirements Banks using deposit funding are under a lot of pressure when not applying negative interest rates on deposits thereby imposing a cost on banks with excess reserves and reducing profitability. Risk of excessive risk increases in investment portfolios in search for higher returns. A prolonged period of low or negative interest rates can cause a break-up in the financial system as we know it and non-regulated/non-supervised alternatives can arise.
Reactions by the banks So far negative policy rates have been transmitted mostly to money market rates. Yet, some banks have imposed charges and fees on large deposits of corporations, driving the return on those deposits effectively to negative territory But until now negative rates have not spread to the households. Institutional and contractual constraints clearly imply downward stickiness. Concerns on substantial deposit withdrawals if passing on the negative rates to retail depositors.
Survey of eurozone bank reactions to ECB policy rates Pct. 20 0-20 -40-60 -80-100 Net interest income Loan margin to enterprises Loan margin to households Lending volume to enterprises Lending volume to households Past six month Next six month ECB, The euro area bank lending survey Q1-2016 81% of the euro area banks have experienced a decline in net interest income over past 6 months. In the same period 27% of the banks indicated a lower margin on loans to enterprises but with hardly no impact on volumes. 21% of the banks have experienced a lower margin on consumer credits and other lending to households with an increase of 14% in lending volumes.
Reduced profitability Unusually low interest rates and an unusually flat term structure erode bank profitability BIS WP No 514, 2015, The influence of monetary policy on bank profitability Term transformation is core business for banks. Bank profitability is very much influenced by the level and slope of the yield curve. Monetary policy rates at historically low levels and QEs are pushing the longer rates down in conjunction with expectations of low inflation rates in the market.
Soundness of the banking sector Soundness of the financial sector might suffer in the long run. Some banks have been able to mitigate the fall in net interest margins by raising fees and commissions. if negative policy rates are transmitted to lending rates for firms and households, then there will be knock-on effects on bank profitability unless negative rates are also imposed on deposits, raising questions as to the stability of the retail deposit base BIS, 2016 How have central banks implemented negative policy rates? It is undisputable that the policy of low interest rates is causing extraordinary problems for the banks and the whole financial sector in Germany Wolfgang Schäuble, Reuters interview april 12 2016
Monetary transmission mechanism Normally there is a close relationship between monetary policy rates and the deposit rates and borrowing rates. But: Existence of downward stickiness in retail deposit rates. When banks hesitate to apply the real cost of liquidity on retail customers the monetary transmission mechanism brakes down. Banks need profit to carry out their intermediation function transformation af short-term deposits into long-term loans. Regulation such as LCR further constrains banks role in the transmissions mechanism. If negative policy rates do not feed into lending rates for households and firms, they largely lose their rationale BIS, 2016 How have central banks implemented negative policy rates?
Monetary policies: more questions than answers Markets depend on central banks more than ever Monetary policy has been supporting/replacing fiscal measures independence of central banks under question? World is swimming in pool of cheap money but where is the inflation? Asset price bubbles? Fuelled by prime ratings? Long-term new normal world of interest-free debts? Where is the bottom of negative interest rates? Unintended consequences redistribution effects where to invest? Not only pension funds are more and more challenged Exit strategies? Timing and pace of Fed tightening? Further easing of ECB? Central banks have been revealing concerns about EMEs but volatility in EMEs is partly driven by QE (feedback loop)? Currency wars? What will be the cost of withdrawal from current MP stance when it gets normalized again?
Conclusions Banks are under pressure for more lending by the monetary policy, but at the same time they have to cope with new and more prudent regulation. Persistently ultra-low interest rates will heavily inflict banks resilience through undermined profitability.
Thank you for your attention Pavel Štěpánek stepanek@czech-ba.cz Eva Zamrazilová zamrazilova@czech-ba.cz