When interest rates go below zero.
“It’s not about money, it’s about sending a message.”
Since the Global Financial Crisis (GFC) the world’s understanding of finance has changed rapidly. One idea that has emerged from the GFC is implementing negative interest rates.
Normally, when you deposit your money into a bank account, the bank pays you a level of interest on your deposit. Negative interest rates are the opposite. Depositing money now attracts a fee rather than an earning with negative interest rates.
Negative interest rates are incentives for banks. The bank holds reserves and these are taxed by the negative interest rate, so the bank has higher incentives to lend out its reserves.
They're are a sign of desperation. It’s a signal that traditional methods have proved ineffective and new options need to be explored.
Global economic growth is reasonably tepid at the moment. In many advanced economies, inflation is very low. So what are the options to cut growth when interest rates are pretty much at zero?
A few countries have said goodbye to zero interest rate policies (ZIRP) and hello to negative interest rate policies (NIRP).
Switzerland was one of the first countries to implement NIRP in the 1970s in an attempt to deter a flood of foreign investment.
So how does this affect me?
It really depends on your bank. Here in Australia, it’s the commercial banks that decide whether to pass on the negative interest rate to its customers. The Reserve Bank of Australia (RBA) sets the cash rate and regulates interest rates.
The RBA has left the door open to more potential cuts if growth and inflation fail to increase over the next few months. There is also potential for the RBA to introduce a negative cash rate if the Aussie dollar remains strong.
Australia and New Zealand Banking group head of Australian economics Felicity Emmett said the RBA will determine the cash rate based off inflation figures which will be released in February 2016.
“The RBA seems more likely to wait until February when it will have another inflation number which will likely confirm the lower than previously anticipated inflation trajectory,” Emmett added.
Your bank might decide to lower or charge its own negative interest rates – it might keep the rates the same as the RBA or change interest indirectly through higher deposit fees.
Pushing interest rates into negative territory could induce more spending and borrowing but it comes with a risk of mass migration out of bonds and savings accounts into cash.
In response to this, governments and banks around the world are attempting to marginalise cash by making it harder and/or less attractive to hold.
Implementing a negative interest rate is an attempt to inject more liquidity - more cash - back into markets and ward off deflation.
Australia’s financial stability
The Australian banking system continues to benefit from strong overall asset performance. Rising house prices in Australia have forced more housing lending which is particularly important to banking stability.
The Australian Prudential Regulation Authority (APRA) in conjunction with the Australian Securities and Investments Commission (ASIC) have implemented a number of initiatives to help guard against housing market risks.
China has been an instrument of growth for Australia and the world post-GFC. Credit grew rapidly along with strong asset price growth. There was over-investment in some sectors of the Chinese economy such as real estate and heavy industry.
Chinese equity prices have fallen by around 35% from the June 2015 peak. Initial price falls were due to policy makers from the Chinese government.