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Bank of England quizzes lenders over preparation for negative interest rates

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Written by: Shekina Tuahene
12/10/2020
The Bank of England (BoE) has written to lenders to ask if they are ready for a zero or negative interest rate scenario. Here's what it could mean for savers and mortgage holders.

Banks are required to fill out a survey detailing how a zero or negative bank rate will affect services, how reliant they are on third parties to accommodate the change, as well as the time and costs needed to implement the rate change. 

In the letter, Sam Woods, deputy governor and CEO of the Prudential Regulation Authority (PRA) said the central bank had been considering negative rates as a policy tool since the 2008 financial crisis and said it was important for it to understand the implications. 

The bank said it was also considering how a tiered approach to negative rates would work in order to reserve renumeration. 

Woods wrote: “We are also seeking to understand whether there may be potential for short-term solutions or workarounds, as well as permanent systems changes.” 

BoE and the PRA will share the responses received to help it build a contingency plan and assess how prepared banks are for the scenario. 

Responses are voluntary and banks have until 12 November to submit answers. 

The possibility of the bank base rate falling into the negative has been speculated since the UK went into lockdown to minimise the spread of the coronavirus, and the rate was cut to a historical low of 0.1%.

The BoE has hinted at the use of negative rates but has said the impact it might have on banks and the wider economy will need to be reviewed.

Most recently, BoE deputy governor Sir Dave Ramsden said negative rates would not be the best way to stimulate the economy and suggested the Monetary Policy Committee were not planning to use to resort to this strategy anytime soon.

The impact of negative interest rates on savings and mortgages

Negative rates should encourage borrowing and discourage deposits and savings. But, in practice, negative interest rates can result in some bizarre outcomes – for savers and mortgage holders, according to Azad Zangana, senior European economist and Strategist at Schroders.

He said it “sounds crazy”, but is true that banks would actually pay you to borrow.

Zangana said: “In this topsy-turvy scenario, the lender would actually pay the borrower. In some European countries, where central bank rates have been below zero for several years, mortgages at sub-zero rates – or “reverse-charging” – are no longer so unfamiliar. Put another way, if your mortgage comes with a negative interest rate, you’ll end up paying back less than you borrowed.

“Where this happens, the bank doesn’t actually make monthly payments to the borrower. Instead, the bank reduces the outstanding capital, thereby accelerating how fast the borrowers reduce their debt. Clearly, where interest rates are negative, there is little incentive for the mortgage borrower to repay debt.”

However, he added that most tracker mortgage contracts currently in force have a mechanism in place which prevents them from dropping below a stated positive interest rate, irrespective of whether or not the BoE cuts its rate. In any case, a high proportion of UK mortgages are on fixed rates, so BoE rate reductions would not apply to those borrowers’ loans.

When it comes to savers, negative interest rates would penalise consumers and businesses for keeping savings in their bank accounts, as their value would decrease over time.

Zangana explained that to avoid charges, some households could decide to withdraw savings from banks and instead invest in a home safe.

“Not only is this a security risk, but the withdrawal of assets from financial institutions reduces liquidity and the ability of banks to lend.”

He added: “Banks would not pay out anything to consumers, who receive zero on their savings, but in the main, investors do not have to pay the banks to hold onto the money for them. Negative interest rates have actually already been put in place in the eurozone, Japan, Switzerland, Sweden and Denmark. And that is what has happened to consumers and businesses in those countries.

“However, savers in Germany are among those experiencing negative rates on deposits but, so far, the majority of those affected are institutions or individual savers with large sums such as €100,000 or more. What savers have to pay for the bank to actually hold their money is sometimes called “depositary charges”. Only recently have smaller German savers been hit by such charges.”

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