Cai Jin

The bane of negative interest rates

They may snuff out entrepreneurship that creates economic growth

In recent weeks, plenty of column inches and TV time have been devoted to the startling new phenomenon of negative interest rates. But if you are looking for evidence of it in Singapore, you will be disappointed.

Rather than sinking below zero, interest rates here have been inching higher. For instance, the three-month Singapore interbank offered rate (Sibor) - the interest rate at which banks lend to each other - has doubled to 1.25 per cent in the past 12 months.

Yet even though negative interest rate may not be biting here in Singapore, it is now a fact of life in about a quarter of the global economy covering wealthy countries such as Japan, Switzerland and even an entire bloc of nations - the euro zone - as they unleash yet another unorthodox measure to battle anaemic inflation and seek to give their economies a boost.

A banking district in Tokyo, Japan, where negative interest rates are now a fact of life. In Singapore, however, interest rates have been inching higher rather than sinking below zero.
A banking district in Tokyo, Japan, where negative interest rates are now a fact of life. In Singapore, however, interest rates have been inching higher rather than sinking below zero. PHOTO: REUTERS

Will this strategy have an impact on Singapore and the rest of Asia, where interest rates are still rudely in positive territory? Plenty, as it turns out, given the deep reach that some of their financial institutions have here.

So far, the countries that have adopted negative interest rates have little to show for it.

In theory, if banks are charged interest on their idle cash balances, they will be incentivised to lend this money out. Similarly, their depositors would be encouraged to take the money out of the bank to spend if they have to pay for the privilege of keeping it there.

However, in Japan and Europe, where populations are ageing and consumer demand is not as robust as it used to be, banks are experiencing difficulties in finding enough creditworthy borrowers to take their surplus cash.

Worse, rather than passing on the negative rates to their depositors, some banks are reported to have tried to recover the cost by raising the costs on loans such as mortgages instead. They are fearful that if they passed on the negative rates, customers may respond by withdrawing the money and stuffing it in their mattresses. That does not exactly encourage consumers to step forward to borrow more.

And because it may be more costly to hold cash in countries with negative interest rates, there has been a mindless rush into gold.

So far this year, the price of gold has jumped 16 per cent in euro terms, 17.5 per cent in US dollar terms and 9 per cent when denominated in yen.

This illustrates one potential side-effect of negative interest rates - the damage they can inflict on the banking system as banks find that while they are forced to trim their lending rates, they cannot scale back whatever little interest they are still paying their depositors.

That puts a squeeze on their net interest margin - the main way they make their money.

The big lenders which have suffered the biggest hits to their share prices this year all come from economies which have adopted negative interest rates, or have big exposures to them.

In the euro zone, these have included Germany, where Deutsche Bank has crashed 34 per cent in price since January, and France, where Societe Generale has plummeted 30 per cent.

Some will argue that even if there is a squeeze on profitability, the selldown is an overreaction as banks are unlikely to face the sort of calamity they encountered during the global financial crisis eight years ago, bolstered as they are by the huge sums of money raised to shore up their capital base.

But it is the reaction to these sell-offs by the banks themselves to try to boost investors' confidence which may be the greater worry.

Deutsche Bank, for instance, offered to buy back over US$5 billion (S$7 billion) of its bonds, with co-chief executive John Cryan stating that the bank was "rock solid". Considering that European and Japanese lenders run huge operations in Asia, any credit-tightening back home may lead them to scale back their operations in the region.

This may, in turn, starve companies of much-needed capital in already struggling sectors such as manufacturing and commodities.

Mr Stephen Roach, the former chairman of Morgan Stanley Asia, noted that in shifting to negative interest rates, central banks are penalising lenders for not making new loans, given the persistence of weak consumer demand worldwide.

"This is the functional equivalent of promoting another surge of zombie lending uneconomic loans made to insolvent Japanese borrowers in the 1990s," he wrote recently.

In doing so, he argues that central banks have ignored the risks of the financial instability they may be spawning.

Imposing negative interest rates tries to force banks to increase the supply of loans, whether there is demand or not. It is not the same as cutting the cost of borrowing in a positive interest rate environment - which has the effect of boosting consumer demand by making loans cheaper and spurring a wealth effect as financial assets appreciate, he added.

How will it all end?

Predictably, investors are looking to see the approach adopted by the United States Federal Reserve after it took a contrary stance to other central banks by hiking interest rates in December - its first such move in a decade.

But keeping cash under the mattress or storing gold - the sort of impact we dread from a negative interest rate environment - is not going to boost economic activity or improve our living standards. In extreme circumstances, it can even cause the real economy to crash by starving it of the much-needed cash that keeps it humming.

That would be a pity. In trying to cure ills like falling demand, negative interest rates may snuff out the entrepreneurship that creates jobs and puts new technologies to work - the very stuff that promotes economic growth in the first place.

A version of this article appeared in the print edition of The Straits Times on February 29, 2016, with the headline 'The bane of negative interest rates'. Print Edition | Subscribe