What is Negative Interest Rate?

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Concept of Interest Rate

Interest rate is the fee borrowers pay for loans or the return depositors receive for their savings, usually calculated as a percentage of the principal. In the case of negative interest rates, instead of earning interest, depositors have to pay a fee to the bank for holding their money. This policy is often used to stimulate spending and investment, especially in deflationary or economic crisis contexts.

Why Are Negative Interest Rates Used?

Negative interest rates are applied during periods of economic recession or when traditional monetary tools are no longer effective. Central banks lower rates below zero to encourage borrowing and consumption rather than hoarding cash.

According to the 2019 IMF report, negative interest rates have been adopted by five major central banks, including the European Central Bank (ECB) and the Bank of Japan (BoJ). In the ECB’s case, deposit rates were reduced to -0.5%, cutting borrowing costs for businesses and individuals but simultaneously pressuring the banking system.

During deflation, falling prices cause businesses to delay production and consumers to postpone purchases, expecting further price drops. Negative interest rates can motivate money to flow out of banks, boosting consumption and investment to counter deflation.

Countries Applying Negative Interest Rates

Several countries have adopted this policy to combat economic crises and low inflation. Switzerland, Denmark, Sweden, and the European Union (EU) are prime examples.

Additional Data: According to OECD, since 2014, 25% of government bonds in Europe have had negative yields. In Japan, more than 60% of government bonds are yielding below zero. This allows countries to borrow at extremely low costs but makes savings less attractive.

The ECB was one of the first institutions to adopt negative interest rates in 2014 to combat low inflation and stimulate growth. It imposed a -0.5% rate on deposits held by commercial banks, encouraging them to expand lending instead of hoarding cash.

Risks of Negative Interest Rates

While negative interest rates can drive growth, they also bring significant risks, particularly to the stability of the financial system.

When depositors are charged fees to keep money in the bank, they tend to withdraw cash or invest in higher-risk assets, such as stocks or real estate. This not only reduces bank liquidity but also risks destabilizing financial markets.

According to a Swiss National Bank (SNB) survey, 32% of savers withdrew a portion of their deposits in the first year negative interest rates were implemented, putting substantial pressure on commercial banks.

Impact of Negative Interest Rates on Commercial Banks

Commercial banks are among the most heavily impacted by negative interest rate policies. Paying interest on customer deposits or lowering loan yields creates significant challenges to maintaining profitability.

• Reduced profit margins: Banks struggle to maintain margins when rates are low, especially in stagnant economies.
• Shift in business models: Many banks resort to increasing fees for services or diversifying their portfolios to offset losses from deposits.

According to the ECB’s 2021 report, the average profits of European banks have dropped by 20% since the adoption of negative interest rates.

Impact of Negative Interest Rates on Individuals and Businesses

Individuals and businesses are directly affected by negative interest rates, experiencing both positive and negative outcomes.

• Encouraged spending and investment: Negative rates make savings less appealing, motivating individuals and businesses to spend or invest in higher-yielding assets.
• Unintended risks: Individuals may shift investments toward riskier assets, increasing pressure on financial markets.

In Japan, after implementing negative interest rates, 55% of personal savings were redirected into riskier financial products, such as equity funds or corporate bonds.

Negative Interest Rates and Their Impact on Real Estate and Stock Markets

Negative interest rates often drive funds into real estate and stock markets, significantly increasing their value. However, this also raises the risk of asset bubbles if low rates persist for too long.

In Sweden, negative rates caused real estate prices to surge by 35% over five years, raising concerns about asset bubbles. An IMF study showed that prolonged negative rates typically increase asset prices by 10% to 15% within the first 2-3 years.

Comparing Negative Interest Rates and Quantitative Easing (QE)

Both negative interest rates and quantitative easing (QE) are tools used by central banks to stimulate the economy, but they differ in their approaches:

• Negative interest rates: Directly impact lending and deposit rates.
• QE: Increases liquidity by purchasing financial assets, supporting market cash flow.

A Brookings Institution study found that QE has a stronger effect on promoting investment, while negative interest rates are more effective in boosting short-term consumption.

Debates and Criticisms of Negative Interest Rates

Negative interest rates have sparked heated debates among financial experts. While some view it as a necessary tool against deflation, others criticize it for harming the banking system and broader economy.

• Supportive views: Negative rates stimulate growth when traditional tools fail.
• Critical views: This policy weakens bank profitability and encourages riskier investment behaviors, potentially leading to financial crises in the long term.

Other Potential Negative Impacts of Negative Interest Rates on Society

Income inequality is one of the adverse side effects of negative interest rates. Asset owners benefit from increased asset values, while low-income earners relying on bank savings suffer losses.

According to the World Bank, in countries applying negative interest rates, 30% of low-income households lost an average of 15% of their savings value due to higher cash holding costs and lower interest rates.

DLMvn hopes this article provides a comprehensive understanding of negative interest rates, helping you assess the impact of this policy on the economy and society in a deeper and more objective way