Sunday 13 March 2016

Will Bank Deposits Pay Negative Interest Rates?

Negative interest rates have been the rage with central banks around the world, with Bank of Japan being the latest one to join the bandwagon in an attempt to stimulate their economy. Will negative interest rates come to Singapore and will banks pay negative interest rates on our bank deposits?

Just to bring everyone on the same page before I answer the 2 questions, central banks are banks for consumer banks operating in the country. Consumer banks like DBS collect deposits from companies and individuals with excess funds, loan out the majority to other companies and individuals to fund their investments and purchases, and deposit a small portion with the central banks. It is a requirement for consumer banks to set aside some money with the central banks to ensure they have adequate resources to handle bad loans and stay solvent in times of crisis. Under the normal scenario of positive interest rates, central banks pay interest on these deposits to consumer banks. Consumer banks also collect interest on loans to debtors and pay depositors interest on their savings deposits. Thus, when central banks pay negative interest rates to consumer banks, will consumer banks pass on this cost and also pay negative interest rates on depositors' bank accounts?

The probability of this happening is almost zero. Assuming consumer banks really were to pay negative interest rates to depositors, it would mean that depositors lose money parking their funds in the banks. Likely, depositors would respond by pulling money out of consumer banks and keeping in their houses and safes. How are the consumer banks going to recall the loans from debtors to pay off depositors withdrawing money from them? Most of these money are tied up in debtors' long-term investment projects and 20- to 30-year housing loans. It is not possible to liquidate these investments quickly and return money to the bank. The consequence is a bank run that is certain to bring down the consumer banks and the economy. Thus, consumer banks will avoid paying negative interest rates to depositors. The most likely scenario is to pay a low but still positive interest rates, like the 0.05% today. Depositors do value the convenience of bank accounts and are willing to tolerate near-zero interest rates.

Having said the above, depositors may still be affected by negative interest rates in some other ways. It is, after all, a cost to consumer banks that they need to recover from somewhere, either from depositors or debtors, or both. While this would not manifest as negative interest rates on bank deposits, it is likely to manifest as higher bank fees, such as the monthly account maintenance fee on current accounts and savings accounts that have balances below a certain threshold, cheque cancellation fees, etc.

On the debtor side, consumer banks are also likely to charge higher interest rates to recover some of the negative interest paid to central banks. However, this is not likely to be significant. Consider the case of DBS, which has $283 billion in customer loans and $19 billion with central banks. Assuming central banks charge -1% on DBS' deposits with them and DBS passes on the cost fully to debtors, the net increment in interest rate on customer loans is only 0.07%.

There is still one more avenue for consumer banks to recover the negative interest. Besides deposits with central banks and customer loans, consumer banks also purchase government bonds issued by central banks. So, if negative interest rates were to happen, consumer banks will attempt to reduce the amount placed with central banks (but no less than the statutory minimum) and shift some of it into government bonds that still pay positive interest rates. It is still placing money with the central banks, just a different avenue and with positive interest rates. This is why when central banks lower interest rates into negative territory, government bonds will rise and their yields will lower. In layman terms, assuming DBS were to pay negative interest rates on consumer deposits, I would withdraw my money and buy the DBS preference shares that have a coupon rate of 4.7%. Either way, I am still lending money to DBS, just that one is called a deposit (with negative interest rate) and another is called a preference share (with positive interest rate). Thus, an important consequence of negative interest rates is asset inflation in government bonds due to consumer banks buying them.

Let us now tackle the other question, which is whether negative interest rates will come to Singapore. As shown above, negative interest rates will actually lead to a slightly higher loan interest rate for debtors and higher bank fees for depositors. It is not as if central banks cannot afford to pay positive interest rates on deposits with them, because, central banks have the authority to print money. Paying positive interest rates on deposits with them is just a matter of allocating more or less of the money they are printing anyway to the consumer banks. So why are central banks willing to adopt such a desperate measure?

The 2 big regions that have implemented negative interest rates are Europe and Japan (the other countries being Denmark, Sweden and Switzerland), which, not coincidentally, are also implementing Quantitative Easing to inject more money into their banking systems. The negative interest rate policy is another measure to prod consumer banks into lending more money to the public rather than hoarding up cash in risk-free deposits with the central banks. In Singapore's case, the loan-to-deposit ratio is very high (DBS' ratio is 88%). Practically all the money collected by consumer banks is put to good use. There is thus no impetus to introduce negative interest rates in Singapore. 

Secondly, negative interest rates will lead to a lower exchange rate of their currencies, thus boosting the competitiveness of their export industries. This is possibly another reason why some central banks are willing to adopt negative interest rates. In Singapore's case, the exchange rate of SGD is managed directly rather than indirectly through the setting of interest rates. Thus, this reason will not lead to negative interest rates in Singapore.

In conclusion, unless things change in future, negative interest rates are unlikely to come to Singapore. Individual depositors will also not need to worry about consumer banks paying negative interest rates on their bank deposits.

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  1. DBS preference shares, how do I make purchase of those, what is the requirement?

    1. The DBS 4.7% NCPS is listed on SGX. You can purchase them thru the brokers like any other shares.