Negative rates and the death of banking
Negative interest rates turn conventional lending dynamics on their head and, bankers say, threaten the liquidity, risk and maturity transformation that lie at the heart of credit intermediation. In other words, they put the entire ethos of traditional banking in peril. Have central bankers misunderstood how the credit transmission channel works in their desperate attempts to stave off deflation?
Negative interest rates are the most honest signal yet of an unspoken market truth: central banks have formally ended the market-based system for credit allocation. Over the last seven years regulators have subsidized lending to targeted sectors – forcing bankers to allocate to favoured markets, clients and business models – and unleashed a flurry of edicts micro-managing banks’ assets and liabilities.
But a negative interest rate policy (Nirp) is a game-changer for the European banking industry. Some €8.7 trillion of eurozone deposits are approaching zero yield. Zero rates on retail deposits and low asset yields squeeze bank net interest margins and curb capital generation while capital requirements are rising.
In recent years, Nordic lenders have imposed extra premia to new lending business to offset margin pressure at the back-end of the loan book. This is not how the credit transmission channel is supposed to work.
In the eurozone, the banking system is struggling with a €1 trillion stock of bad debts, moribund credit demand, regulatory controls and a crisis of confidence in bank business models. Could negative rates prove not just counter-productive to Europe’s attempts at reflation, but the final straw for Europe’s already weakened lenders?
Many of the bankers interviewed by Euromoney believe it could be.
They say the monetary experiment is unsustainable. To the extent lenders are incapable of transferring the cost of negative rates to their depositors, the reduction in bank earnings could reduce credit supply and eventually tighten lending conditions, bankers warn.
Four European central banks have pushed rates into negative territory. The ECB cut the deposit rate to negative (meaning lenders are now charged when they park cash at the central bank) in June 2014. In March, amid protests from bankers, the ECB cut the deposit rate to -40 basis points and its main refinancing rate to zero.