Negative interest rates: how low can they go?
- Dr Ru Xie
Negative interest rate policies have been introduced in Europe and Japan to stimulate flagging economies. But the unconventional monetary strategy may be doing more harm than good.
Our research identified new evidence that bank margins and profitability fared worse in countries where negative interest rates were adopted than in countries that did not pursue this policy.
Working with researchers from Bangor Business School, the US Department of the Treasury and the University of Sharjah in United Arab Emirates, the University of Bath study suggests negative interest rates – where nominal rates are set below zero percent – may have backfired.
Zero-sum game
Since 2012, Japan and six European economies – the Eurozone, Denmark, Hungary, Norway, Sweden and Switzerland – have introduced negative interest rates, making it costly for commercial banks to hold their excess reserves with central banks.
Negative interest rates are supposed to stimulate the domestic economy by facilitating an increase in the demand for bank loans.
In theory, this could increase new capital investment by firms and domestic consumption, via credit creation. But the research showed bank margins were being squeezed, curbing loan growth and damaging banking profits.
Here to stay?
Our study shows negative interest rate policy is failing, particularly in an environment where banks are already struggling with profitability, slow economic recovery, historically high levels of non-performing loans, and a post banking-crisis deleveraging phase.
If they’re not working, why continue them? This is a good question.
In a paper published in September, US investment bank JPMorgan estimates that Europe may face “another eight years” of negative interest rates. In December 2019, Sweden, one of the pioneers of negative interest rates, ended its policy.
“Monetary policy may be able to prolong the current [business] cycle, but ultimately we do not think it can prevent recession,” said Bob Michele, global head of fixed income at the bank's asset management arm.
“Eventually, this cycle will need to see a decisive shift from monetary to fiscal policy,” he added.
Dr Ru Xie is Associate Professor of Finance, University of Bath School of Management. She is part of the research team who published ‘Bank margins and profits in a world of negative rates’, along with Professor Philip Molyneux from the University of Sharjah, Alessio Reghezza from Bangor Business School and John Thornton from the U.S. Department of the Treasury. The research papers have been published in the Journal of Banking and Finance, and the Journal of Financial Services Research