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Author: Tim Wallace
NOTE: ARTICLE ORIGINALLY APPEARED ON TELEGRAPH.CO.UK
JULY 30, 2016
Negative interest rates: necessary
evil or symbol of greed?
“OH PIGGIES!”
The children joyously shout in the famous NatWest advert of the
Eighties, highlighting the historic piggy bank family characters given
to loyal savers over the decades.
“At NatWest, we’ve been helping families save for generations,”
said the reassuring TV voiceover.
Yet suddenly a foundation of the savings industry is at risk.
An astonishing prospect has arisen – rather than receive interest,
those with money in the bank might have to pay for the pleasure.
Instead of helping you save money, the piggies might start eating
it. It comes as savers have already been under the cosh for years,
struggling with record low interest rates.
Last week NatWest and its parent, the Royal Bank of Scotland,
raised the prospect of negative interest rates in letters to 1.3m
business customers.
There are no indications that the rates are going to be imposed
imminently, nor that savers or individual current accounts are at risk,
but by now the idea is firmly lodged in the minds of worried families.
Negative interest rates turn the world of savings on its head in a
mindboggling reversal of the obvious and important incentives
of the industry.
Usually a person is paid to save, receiving interest on their cash.
That encourages people to put money away for the future, choosing
not to spend today but to wait for the money to grow into a larger
sum in the months and years ahead.
The other side of the transaction is borrowing. If an individual or
business wants to spend now rather than save up for an investment
or big purchase, they have to pay for the funds in the form of
additional interest costs.
Customers find it hard to understand the idea of turning that upside
down, and small businesses with accounts at NatWest, and its parent
Royal Bank of Scotland, have reacted with disbelief.
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“The potential for the profit that we’ve worked so hard to achieve to
shrink in our account seems incredulous and disheartening,” says
William Hunter, who co-founded his air freshener business Purity
Fragrance in 2012.
“When you consider that NatWest/RBS was bailed out by the
government with taxpayers’ money this letter almost feels like
a symbol of greed.”
Mr Hunter received a letter from the bank this week warning that
rates could turn negative “depending on future market conditions”.
The bank has also increased his monthly fees from £26 to £81.
“In all, it feels like NatWest are working hard to encourage
small businesses to leave, and we will, once we have assessed
alternatives,” he says.
One problem with that approach may be that if one bank goes
negative, others could follow. Currently the big banks are very
well funded and so do not need to work to attract small
business deposits.
If they were overwhelmed by a flood of customers switching
accounts, the other banks might find themselves with far more
deposits than they need, prompting them to send interest rates
negative too, driving away those excess funds and saving
money on their interest bills.
We are not yet at that stage – while rates are very low for savers
and at zero on a typical business account, banks remain wary of
dipping into negative territory.
However, potential trigger points remain which could tip British
banks over the threshold.
This Thursday, the Bank of England will reassess rates, and markets
anticipate a cut from 0.5pc to 0.25pc.
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Author: Tim Wallace
Previously officials had thought of 0.5pc, as the practical minimum
for rates as a lower level would squash banks’ profits, but lenders
have chopped costs and become more efficient in recent years,
opening the door for a cut.
It is possible that this could prompt banks to cut rates on deposit
accounts to below zero.
Banks make profits on the margin between the amount they pay
for funds – either in accounts or in financial markets – and the
interest rate they receive on loans.
When the Bank of England cuts rates, the income from loans falls,
particularly on those such as tracker mortgages which are linked
to the base rate. But if the rate paid to customers with current
accounts or savings accounts already stands at close to zero, then
banks have not been able to protect their profits by going negative.
As the rate on loans has fallen gradually in recent years, this has
squashed bank profits. A central bank rate cut could push them
over the brink, or encourage banks to raise funds in other ways,
for instance by increasing fees on accounts and on loans.
Even if it makes customers highly uncomfortable, in theory that
will please central banks – the aim of low rates is to encourage
borrowing and spending, pushing firms and households to spend
now rather than waiting for tomorrow.
To see what impact the rates could have, it is worth looking at
other countries which have tried negative rates.
The European Central Bank charges banks to keep money with it,
and the Bank of Japan went to minus 0.1pc earlier this year.
Earlier examples are found in the Nordic states which may offer
the best case study for British lenders, while Switzerland also has
negative rates. Sweden’s Riksbank cut its base rate to minus 0.1 pc
in February 2015, gradually cutting further to minus 0.5pc in February
this year, offering more time to observe the policy in action.
If they cannot cut deposit rates, banks are squeezed when rates fall.
They can, however, seek alternative ways to cut funding costs rather
than simply hiking fees to make up the gap. “Banks have
had a capacity in Sweden to increase margins as rates fall –
in this environment mortgage bonds become less costly to issue,”
says Dahlberg.
That is because big investors are keen to buy bonds backed by
high quality residential collateral, giving the banks more funds to
lend on again to new mortgage customers.
When rates turned negative, banks found the cost of raising funds
from those institutions fell faster than the rates paid by mortgage
borrowers, improving profits for banks in that market.
Nonetheless, overall banks’ profits were put under pressure.
British banks have done some scenario analysis to investigate
the impact of negative rates.
Barclays, for instance, believes it would take a £412m hit per year
if the base rate fell to minus 0.5pc. Even then, some parts of the
business would benefit – Barclaycard, for instance, would benefit
modestly as the fall in funding costs would be greater than any
fall in credit card interest rates.
Britain’s banking chiefs are adamant they will do all they can to
avoid imposing negative rates on deposits.
“
At the moment even if rates go negative –
and I’ve discussed it with colleagues since the
RBS announcement – we can’t envisage any
circumstances where we’d say to our deposit
customers, you need to pay us to stay here.
says Virgin Money’s boss Jayne-Anne Gadhia.
”
Large companies in Sweden are typically willing to pay negative
rates to keep cash with their banks, as the other available places
to store money – the bond markets, money market funds,
and short-term loans to other businesses – will likely charge
them even more.
“But who knows what the future holds, the world is very different
to the world we’re used to.”
Small companies and individuals, however, do not pay negative
rates – they simply get no interest, leaving them at the mercy
of inflation but at least preserving the cash in their pockets.
Craig Donaldson, chief executive at Metro Bank, echoed those
sentiments: “We have no plans to introduce negative interest rates,
absolutely no plans,” he said.
“There is an awareness that being too harsh on small companies
is not a productive way of maintaining growth, or credit risk in the
long run,” says analyst Kristin Dahlberg at Jefferies.
The same is true at the bigger banks.
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C2FO in the news
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Author: Tim Wallace
“We don’t have any current plans to do what RBS did [to change
its terms and conditions],” said Lloyds Banking Group’s chief
executive Antonio Horta-Osorio, adding that he does not believe
the Bank of England will cut its base rate to below zero.
“I don’t think they would go negative because it transmits a very
negative signal to the economy, and the European experience
was not good at all. So I don’t think they will go into that space
and we don’t have any current plans to do that,” he said.
Despite triggering the latest bout of worry over negative rates,
RBS also says it “will do our utmost to protect our customers
from any impact”.
One rival banking chief even believes RBS sent its letter to
small businesses deliberately to focus policymakers’ minds on
the negative impact of sub-zero rates in the hope of keeping
rates positive.
“My view is they made that announcement as a means of pointing
out to the Governor [of the Bank of England] that it isn’t all upside,”
the top executive said. “In other words, this is one of the potential
consequences of you cutting base rates that you might want to bear
in mind. Small businesses would react badly – you can guarantee
that – and will be writing letters of protest to [Chancellor of the
Exchequer] Mr Hammond about the situation.”
While banks may be clear in their intentions, it is harder for bank
customers to know how to prepare for negative rates if they do
come along – or even for lower rates, given savings have already
been squeezed hard.
“
The only thing really savers can do is to go
for fixed rate bonds, which are quite low
but are paying the better of the rates in the market,”
says Charlotte Nelson from savings
analyst Moneyfacts. “I would be wary of fixing
for a long time, but might fix for two or three years,
and then put some money into an easy
access savings account or a high-paying current
account so that you have access to some
money if the market changes.
”
Andrew Burns, an adviser at C2FO, recommends firms get their cash
out of the door fast, for instance by negotiating a discount on bills in
return for paying more quickly than normal – dodging an interest bill
from the bank and saving money with suppliers.
Failing that, you can always put your cash in those old NatWest
piggy banks.
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