Central bankers have been battling with interest rates since the crisis, making the management of capital even more difficult for bankers. The answer, according to a recent report by Citi economists, could be to abolish currency, and use alternative stores of value.

Central bankers worry about how to get interest rates lower and even negative. Bankers worry about how to deal with interest rates when, eventually, they rise. Together, these sentiments indicate what an upside-down world we have been living in – in the US and Europe particularly – ever since the financial crisis, and the long bouts of monetary easing it has led to.

For central bankers, the favoured approach of rebooting the economy by asset purchases has had mixed results and caused huge side-effects – asset price inflation that, in turn, produces distortions in the economy and the potential for financial instability (ironic, since the reason central banks started down this road was to stave off the economic impact of the financial crash).

While the European Central Bank (ECB) has only recently started along a road of purist quantitative easing, there are concerns that the policy generally has run out of steam, even though economic conditions suggest that more stimulus may be required. So where to go? Citi’s economics team suggests that negative interest rates have some advantages over asset purchases but they must overcome one major obstacle – the existence of cash.
 
Yes, that's right, you read that phrase correctly – the existence of cash. The problem with cash is that it does not pay an interest rate and so “when the prevailing [risk-free] nominal interest rates on non-cash stores of value are negative, cash becomes increasingly attractive as a store of value”. In other words, institutions that can borrow from the central bank at negative rates would simply put the proceeds into cash and make a turn rather than lending them out.

The answer? Abolish currency and use alternative stores of value, such as electronic payments. The Citi economics team – Willem Buiter and Ebrahim Rahbari – accept that the political backlash from this idea could be more severe even than the furore over quantitative easing – which has been criticised for favouring deleveraging banks and asset owners over pensioners with small pots of savings who consequently see their incomes diminished.
 
“We anticipate howls of horror from various sources, notably German savers and their representatives…” say Mr Buiter and Mr Rahbari in their paper, 'High time to get low: getting rid of the lower bound on nominal interest rates'.
 
But, as there are currently four central banks with negative policy rates – the ECB, the Danish Nationalbank, Swiss National Bank and the Swedish Riksbank – discussions about their impact are definitely relevant if somewhat fantastical.
 
Meanwhile, commercial bankers, who should welcome the prospect of higher rates in the US and the UK, as they bring with them the scope to improve net interest margins, are fretting about them. There are concerns about attrition of deposits in a competitive environment, about taking the correct decision on raising deposit rates and about getting the strategy right to maximise income in a rising rate environment. Basel III makes it all the more complicated because liquidity coverage needs also have to be factored in.

Banking analytics company Nomis Solutions describes in a research paper the challenges faced by deposits managers during the crisis. “[They] range from managing the dislocation between market rates and deposit rates, focusing on growing the deposits base to repair bank balance sheets, reducing the cost of deposits to repair profits and losses, and dealing with the potential for an upward cycle while managing the multiplicity of other agendas,” says the report.

With rates on the floor for so long, rate rises in the next cycle are particularly challenging for deposit managers to deal with, and they will need to ensure they have the best strategies and systems in place. 

The longer the current unprecedented low-interest environment continues, the more we will find central bankers and bankers worrying about the consequences of being in – and moving out of – unchartered territory.

Brian Caplen is the editor of The Banker.

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