Financial institutions are not yet ready for the possibility that US official interest rates could go negative in a bid to revive economic growth. A number of major developed countries have negative rates. Will the US follow suit and if so, what should lenders do?
US institutions aren’t ready for possible negative official rates – which already operate in countries such as Japan and Switzerland – making them vulnerable if the US Federal Reserve takes this step, a survey finds.
The US central bank’s Fed funds rate is between zero and 0.25 per cent. In Japan, the official benchmark is 0.1 per cent; in Switzerland, the rate is 0.75 per cent. The UK’s Bank of England (the rate is currently 0.1 per cent) has reportedly hinted at moving to negative rates. Already, Swiss bankers, for example, have complained that negative rates have hurt margins and caused a real estate bubble. The situation has arguably played a part in encouraging some Swiss banks to merge.
A study of 47 financial institutions by the Risk Management Association finds that 84 per cent of them would not be prepared to operate immediately if rates go into the red. Some 70 per cent of respondents to the RMA’s study said negative rate risks are below 10 per cent. Even so, the RMA said organizations need to get their act together.
"Negative rates in the US are unlikely for now, but definitely not impossible at some point," Nancy Foster, President and CEO of RMA, said. "Now is the time for banks to think the unthinkable and get ready for something that has already happened in other major economies.”
The survey appears in the RMA’s White Paper, Focus on the Negatives: Banks' Assessment of the Potential for a Negative US Rates Policy - And Their Preparedness. The institutions surveyed ranged from global to regional in their scope.
Some 75 per cent of respondents would be ready within one year and that many agree with the widely held assumption that the US Federal Reserve would give advance warning of a negative rates policy, although estimates of the length of that warning period vary.
Sixty per cent of respondents to RMA's survey say their software and systems can handle negative rates across five classes of models and scenarios.
Thinking the unthinkable
There are a number of reasons why banks should prepare, the RMA said. For example, central bank statements have not ruled out negative rates; a number of major developed countries now employ them; negative rates should form part of stress tests that banks customarily run; futures prices already imply that US rates are negative, and some economists are already arguing for such rates.
The extraordinary market and economic events of 2020, with lockdowns and social distancing crushing GDP earlier in the year, and the associated massive rise in public debt, have raised the chances that central banks will try and boost the money supply to prevent a crunch. On the flipside, if holding cash becomes a cost, this could force savers to put money into riskier equities and other sectors, inflating asset prices and ultimately, reducing the real savings necessary for long-term capital investment.
This publication has been told by wealth managers that whoever wins the US elections next week, policymakers may become increasingly receptive to adopting a form of what is sometimes called Modern Monetary Theory (MMT). MMT claims that government can spend more freely by borrowing or printing money than is assumed by conventional monetary models. MMT advocates say governments can pay for goods, services, and financial assets without a need to collect money in tax or debt issuance in advance of such purchases. They also claim that governments cannot be forced to default on debt denominated in its own currency. Critics say these views are naïve, and previous attempts to print money to pay off heavy debts inevitably produce inflation and a subsequent bust.
The RMA survey was carried out in July.