BoE official revives negative rate speculation - World -
BoE

No evidence that below-zero rates have reduced bank profits overall, says external MPC member Silvana Tenreyro.

A speech from a Bank of England (BoE) official last week rekindled speculation that the central bank might be seriously considering cutting the UK base rate, currently at 0.1%, into negative territory, because it could provide a significant economic stimulus.

There has been robust debate within the BoE over the past year about the merits and risks of adding negative interest rates to its monetary toolkit. The issue was floated last summer, after which BoE policy-makers appeared to row back on the suggestion.

If ever used, negative interest rates could crush the profitability of some banks.

A paper from the European Central Bank in 2017 concluded that the impact of negative interest rates is moderate depending on a bank’s business model. Those with diversified income streams are perceived by the market to be at lower risk than those reliant on deposit-taking for their funding.

Unlike with retail deposits, banks are much more likely to pass on negative rates for corporate deposits.

Nonetheless, the lack of bank profitability across much of Europe, where a negative interest rate policy (NIRP) has been in force, is a factor behind lenders’ struggle to generate retained earnings, a key worry for prudential regulators. Retained earnings help banks maintain capital buffers.

Growth boost

“My overall assessment is that, while we can never have complete certainty, negative interest rates should, with high likelihood, boost UK growth and inflation,” said Silvana Tenreyro, an external member of the monetary policy committee (MPC) at the BoE, in a speech on January 11.

“There is no clear evidence that negative rates have reduced bank profits overall, and a number of studies find positive impacts, once you take into account the boost to the economy.”

Negative interest rates should, with high likelihood, boost UK growth and inflation

Silvana Tenreyro, external member, MPC

However, Ms Tenreyro acknowledged that the current structure of the UK banking system could see NIRP negatively affecting bank profitability. “At worst, in my view, it could make bank lending channels slightly less powerful than otherwise, while I expect the financial market channels to work normally,” she said.

Ms Tenreyro explained that these were her personal views and that her speech was not necessarily a signal that the BoE was about to pursue NIRP. She added that NIRP could be a useful response to challenging economic conditions, particularly when inflationary pressures are low.

“Once the BoE is satisfied that negative rates are feasible, then the MPC would face a separate decision over whether they are the optimal tool to use to meet the inflation target given circumstances at the time,” she said. Ms Tenreyro has a vote on the MPC.

Ms Tenreyro added that the central bank is engaging with firms around operational considerations regarding the feasibility of negative interest rates. The BoE wrote to banks in October 2020 to gauge their views on introducing NIRP and seemed primarily concerned about unintended operational disruptions.

Most analysts argue UK banks could withstand NIRP even though it would hurt their profitability. However, in October 2019 the Swiss Bankers Association published a report stating that following five years of NIRP in Switzerland, there was a risk of asset bubbles forming, indebtedness had increased, a feeling of ongoing crisis has been perpetuated, jeopardising the stability of pension funds. Additionally, NIRP sucked SFr2bn ($2.3bn) out of banks in 2018, significantly reducing their profitability.

NIRP effective elsewhere

Observing the experiences of other jurisdictions that have implemented NIRP, such as the eurozone (since 2014), Switzerland (since 2014), Sweden (2015-19) and Denmark (since 2012) and Japan (since 2016), Ms Tenreyro said they showed monetary policy transmission has worked effectively. She said this has been manifested through standard cost of capital and exchange rate mechanisms and higher asset prices. “[In the UK] these effects should lead to higher consumption and investment, and boost net exports and inflation. Quantitatively, these channels are an important part of monetary policy transmission,” she said.

In addition, Ms Tenreyro said NIRP has been effective in boosting lending activity adding: “A number of studies find positive impacts, once you take into account the boost to the economy.” Indeed, a number of academic studies show that NIRP has spurred banks into more lending, sometimes at the riskier end of the spectrum.

An IMF paper in 2018 looking at Japan showed that more exposed banks increased credit and took on more risk compared with banks that were less exposed to negative rates.

Real estate lending is a massive part of the UK banking market. One concern is that lax lending standards by banks to boost profits in response to NIRP could lead to an overheated property market, followed by a bust at some point, leaving bank balance sheets in shreds. Despite the Covid-19 pandemic, the UK has already been experiencing rapidly rising house prices, partly because of temporary tax break on home purchases due to expire in March.

In one respect at least, NIRP seems to contradict liquidity measures put in place by the Basel Committee on Banking Supervision, which favour retail deposits as a stable source of funding as they are seen as ‘sticky’.

Though NIRP does not always affect deposit flows, the deeper and longer central banks pursue NIRP the harder it becomes for deposit-takers to pay positive rates to savers. Apart from potentially pursuing more risky lending practices, banks may respond to NIRP by hiking overdraft fees, or charge for current accounts, which are normally free in the UK if account holders’ cash balances are positive. Changing the status quo would not be popular with the UK public.

A version of this article first appeared in The Banker's sister publication Global Risk Regulator.

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