What is... | January 19, 2015

What is a negative interest rate?

When savers deposit money in the bank, many check to see the interest rate – or return – the money will earn. However, a “negative interest rate” is occasionally introduced in certain circumstances for certain “savers”.


When this happens, the depositers get back less money than they put in and are effectively charged to keep cash in an account.
These unusual circumstances made headlines mid-2014 after the European Central Bank introduced negative interest rates for the first time and as the Swiss National Bank announced negative interest rates to come into effect in January 2015.
Retail customers are typically shielded from most of the effects – but there is no guarantee that will always be the case.

Worried about return – not rate of return
Negative interest rates can be introduced for several reasons. However, the economic conditions are typically characterised by high financial risk such that savers are less worried about the rate of return on their money than the return of their money full stop.
A 2011 study of the history of negative interest rates details how academic debate about negative interest rates dates back to the 19th Century then rose to popular attention in the wake of the global financial crisis that started in 2007.
Negative interest rates are unusual – or have been in the past – but are perhaps becoming more common. In 2012 and 2015, the Danish central bank used negative interest rates, as did Swedish authorities in 2009 and the Bank of Japan in October 2014.

When central banks are in the driver’s seat
In the cases of the European Central Bank and the Swiss National Bank, central banks’ policymakers made the decision to use negative interest rates.
An ECB statement lays out the reasons why – essentially amounting to helping it achieve its goal of stable prices over the medium term.

When markets are in the driver’s seat
Negative interest rates can effectively be introduced in the bond market as well but, in this case, the market drivers of supply and demand are in the lead rather than a central bank.
If the bond is seen as a relatively safe investment, there can be a “flight to quality”, with demand so great that the price is pushed up in the market.
It doesn’t alter the coupon payments but the final payment will be noticably less than the buyer’s investment.
Although bonds are usually considered to be at the low end of the risk spectrum, this is a demonstration that they are not “risk free”.

If fees are too high, may negative returns apply
Negative interest rates serve as a warning to take fees and charges into account, no matter the economic climate.
If fees and charges on a saving or investment are higher than the rate of return, conditions are akin to that of a negative interest rate.

Will it cost me?
Despite negative interest rates becoming more common, so far there is little cause for concern for retail savers – and potentially cause for celebration for borrowers.
The ECB announced its negative interest rates only applied to banks that deposit money in certain accounts.
It says banks might lower interest rates for savers – although, on the flipside, it also may make it cheaper to borrow.

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eZonomics team
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