Thursday, February 11, 2016

Negative Interest Rates: Technical Readiness

The Fed has told banks to be prepared for negative interest rates, at the same time saying that it’s not a likely scenario. The most likely scenario would seem to be a copy of Japan, where banks are being charged an annual rate of 0.10 percent for excess reserves on deposit with the central bank. It’s a way of discouraging banks from keeping cash. The hope is that banks will be more eager to make loans, but for banks that don’t want to make loans, there are plenty of other places they could put their money. A small amount of it could be in gold, for example. Banks may need to keep excess reserves on deposit for short periods of time while large transactions clear, and the negative interest rates could lead banks to charge higher transaction fees, but not so large that they would deter the large business deals the payments are part of.

There has been confusion this week about the Fed’s plans. As I understood it, the Fed only meant to caution banks to be ready in a technical sense for interest rates that could go below zero. The United States has never had negative interest rates, so it’s not likely that many of the old-line banks are technically prepared to record the negative interest rates in their transaction systems. In clarifying its position, the Fed said it had no plans to lower interest rates. That compounded the confusion, though, and today the Fed had to clarify that it could adopt negative rates in the future and banks really did need to prepare. That’s the bottom line, I think: bank managers need to go to their computer system architects to ask, “If we tried to put in a negative interest rate tomorrow, what would happen?” Someday bank stress tests may be more than just back-of-the-envelope calculations and banks may be formally obliged to test their operational readiness for scenarios such as these.

Update, February 12: CNBC just published a roundup of negative interest rates: Next country with negative rates could be… Canada?