April 2016

The dawn of negative interest rates is nigh. The world appears to be upside down since the Negative Interest Rate Policy (NIRP) – an exceptional monetary policy tool that brings nominal target interest rates below the zero bound – has changed the rules of the interest rate game for financial intermediaries. Anne-Katrin Brehm, Institutional Cash Management at Deutsche Bank looks at what those new rules mean for the transaction banking and cash management business

Why are negative interest rates a global challenge?

Brehm: The world was first confronted with close to zero interest rates immediately after the financial crisis. Central banks normally cut interest rates when their economies face lower inflation. What is new this time is that several central banks have taken the decision to cut rates below zero almost simultaneously, thereby catapulting financial markets into a new environment and challenging the architecture of those markets despite not fundamentally being in a crisis. It is indeed a scenario that has gained increasing traction across the globe. The entire financial market was alerted since financial institutions now have to pay for depositing money. From a theoretical as well as from a mathematical perspective negative interest rates are possible. However, they are counter-intuitive.

What are the different reasons for negative interest rates globally?

Brehm: Countries’ central banks that introduce negative interest rates do so in order to boost their economy. For example, the main rationale for introducing them in the Eurozone was to raise inflation while Denmark and Switzerland introduced them primarily to prevent a steep currency increase. Central banks also apply negative interest rates differently. For example, Japan and Switzerland apply ‘thresholds’ with tiered pricing structures instead of applying negative interest rates from the first currency unit onwards. European Central Bank (ECB) Governor Mario Draghi was recently asked why the ECB is not considering a tiering system of negative interest rates like that implemented by the Bank of Japan. He replied that the ECB did not opt for such a system not only because it cannot extend these rates for as long as it wants to but also because of the unique complexity of the payment system in the Eurozone, with many banks of different sizes, different lending conditions, and in totally different market situations.

How are the transaction banking and payments business and their core clients impacted by negatives interest rates?

Brehm: Negative interest rates have a fundamental impact on the commercial banks’ core business activities which makes it even more complex to deal with. The cash management business with its underlying payment system architecture, in particular, is clearly affected by negative interest rates, which have a fundamental impact on end-of-day liquidity. Commercial banks still have to keep end-of-day liquidity with their central banks overnight for different purposes, such as clearing balances. These balances represent settlement balances for clearing purposes to facilitate the payment obligations on behalf of clients in the morning of the next day. This requirement will not change due to the negative interest rate environment as this is at the heart of the payment flow. However, banks now face costs for holding these balances in keeping with their operational behaviour. Furthermore, there is no homogenous view from economists and central banks on the ultimate economic benefits.

How low could interest rates go and are there silver linings?

Brehm: Most negative rates are in the range of 0.1 to 1.0 per cent. Of course there is a danger that if central banks push rates too far into negative territory that the entire financial system would have to cope with new facets of systemic risks. Again, in the last ECB Council meeting, Governor Draghi ruled against the possibility of a tiering system – or taking rates as low as the central bank wants to without consequences. This shows that the ECB itself realises that this is not a never-ending scenario and there is a maximum level that is absorbable for commercial banks. This may be reached once we see more and more commercial banks start to introduce negative rates to their clients, which is not a decision to be taken lightly. Limiting resulting costs should not be contradictory to what central banks try to initiate with negative interest rates.

Negative interest rates may lead to an excessively cash based financial system. What are the risks of this?

Brehm: Several macroeconomists believe that once the negative interest rate environment becomes commonplace that more and more sectors of the economy would become physically cash based. This could prompt industries to keep more bank notes in vaults instead of with banks. This may also affect the transaction flow because physical cash needs to be transferred and translated from the pre premises back into electronic cash before the initial transaction occurs. Should this become a common situation, it could negatively affect the core activity of the transaction and payments business and the global economy would shift gears. This would be contradictory to the actual speed resulting from Intraday Liquidity Management, for example.

Why are negative interest rates a structural rather than cyclical issue for banks?

Brehm: The last two to three years have highlighted that negative interest rates are not a short term issue but one that will persist for a longer period. Since macro-prudential tools are most effective if they complement rather than oppose the direction of monetary policy, it is rather a structural than a cyclical issue which we have to cope with. The application of negative rates towards clients is a pricing decision. Thus it is a selective decision of individual banks in the competitive market space. Judging by interest rate swap curves, the market expects several countries to stay in negative rate territory for a few years. The uncertainty about the actual implications has reinforced the need for tighter communication among market participants and for forecasting cash flows to enable a smooth transaction flow and a cost-limited use of funds. Collaboration among central bodies, commercial banks and their clients is critical to handling the new situation. Financial market participants should not only analyse and understand the implications of macro-economic and financial market fundamentals but they should also validate the constitution and technical plumbing of their systems and banking products are compatible with negative rates. Additionally, contractual arrangements as well as practice and investment guidelines may need to be adjusted under the new lens of negative interest rates.

Anne-Katrin Brehm

Institutional Cash Management, Deutsche Bank


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