Banks are seriously discussing negative interest rates for normal people's savings

The concept of earning interest on money in the bank is so deeply ingrained into economic life that few people even know that the opposite can happen too: Banks can take a percentage of cash from your account in the form of negative interest rates, under certain conditions.

Normally, this doesn't happen. Banks want your cash, and pay you interest on it, because the more deposits they have, the more they can lend it to others who pay them even more on their investments.

But interest rates in Europe are so close to zero — and economic activity is so sluggish — that some central bankers are seriously discussing whether they should drive interest rates into negative territory in the future, as a sort of economic punishment for not spending money. The theory is that if you are deterred from keeping cash in the bank you'll withdraw it and spend some of it, thus creating economic growth.

Europe's central banks and the US Federal Reserve have kept interest rates near zero for years now in the hopes of making money cheap to borrow. The intent is that because it costs next to nothing to borrow money, you'll take advantage of that and invest it in anything that pays more than a 0% return. That usually creates inflation too, as the influx of cheap, new cash devalues the existing stock.

But inflation is nowhere to be seen. The price of oil has fallen dramatically, making anything that requires fuel cheaper. And with prices falling, people hold off on spending today because they know their money will be worth more tomorrow. That lack of economic activity despite the cheapness of lending is exactly what is holding the economy back.

'We also expect the ECB to remove the lower bound, leaving the door open to go more negative.'

In an attempt to break this deadlock, four European central banks (the ECB, SNB, Riksbank, and Denmark’s Nationalbank) have already imposed negative "policy" interest rates. These are nominal negative rates they charge in their direct dealings with other banks. None of those negative rates have passed through into the consumer banking system — yet.

But now bankers are talking about whether it's time to do just that, in order to force you to make cash withdrawals. In a note to investors this week, Credit Suisse analyst Christel Aranda-Hassel says she expects the European Central Bank to cut its "deposit rate" for banks even further into negative territory, from -0.2% to -0.3% in December. "Crucially, we also expect the ECB to remove the lower bound, leaving the door open to go more negative if needed," she wrote.

With negative institutional lending rates forming a de facto tax on banks that store money with other banks, those banks will become increasingly incentivised to pass costs on to consumers.

A radical alternative: 'Impose controls on cash withdrawals.'

 

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Deutsche Bank analysts Abhisek Singhania and Oliver Harvey discussed the same thing, in a separate note to investors: "It may be that the direct cost to banks is not yet sufficiently high to justify passing it on to depositors. The direct costs of negative rates to the Swiss banking system amount to around USD 1bn per year."

As those costs mount, they need somewhere else to go. Consumers are at the end of the banking chain, and negative interest costs can ultimately be passed to them if banks choose. That might flush money out of banks and into the economy where it's needed, but it would also create an "Alice in Wonderland" situation, in which banks suddenly start discouraging consumers from depositing cash with them.

The problem then becomes whether consumers would actually spend their withdrawn cash or hoard it physically. Hoarding would have several weird distorting effects on society, including a new incentive for burglars to loot houses looking for piles of money under mattresses. So further harsh policies that would restrict consumer access to cash might need to be imposed, Singhania and Harvey wrote:

Bank of England policymaker Andrew Haldane has recently discussed the opportunities provided by digital currency to overcome the zero lower bound problem. If central banks were faced by deposit withdrawals, a less radical alternative could be to impose controls on cash withdrawals. Given the potential social and political problems arising from such a policy, thresholds could be set sufficiently high to encompass only very high net worth individuals. Some European nations have already announced restrictions on large cash purchases and monitoring of cash withdrawals to combat illegal economic activity.

'Tax currency holding ... or abolish it altogether.'

That sounds extreme. But Haldane is not the only central banker wondering whether it might be the next step. In a speech in May, titled "How binding is the zero lower bound?," Benoît Cœuré of the ECB said banks may either have to tax physical cash or ban it:

... perhaps the most prominent proposal is to either to tax currency holding à la Gesell [an economist who invented the idea of negative interest] or abolish it altogether, and hence to remove the arbitrage between bonds and cash. One can indeed imagine several advantages associated with such a policy, on top of pushing the lower bound further into negative territory. For example, tax on cash can act like a tax on illegal activities and would foster greater transparency. In addition, we could economise on the costs of storage and use of currency, which are not insignificant.

The mere fact that bankers are even discussing negative rates for consumers is scary. Of course, Cœuré was not suggesting that should happen right now. It would be deeply politically unpopular, since most people regard saving and thrift as virtues, and not an activity that should be punished. Cœuré concluded:

Savers already perceive a negative nominal interest rate on deposits as an unfair wealth tax and extending it to cash would deepen this perception and affect even more vulnerable members of our society.

So don't expect negative savings rates anytime soon.

But one thing you might want to look for, however, is disguised negative rates. As costs for institutional lending go up under negative policy rates, banks might pass on some of those costs to consumers in the form of one-off charges or commissions, and everyone knows what those look like on a bank statement.