270912019 How does negative interest rates policy work? - The Economic Times Tue Ecoyomic Tine oie poe Senin ee pr eee wisri2a 131.00 1,093.50. 7.00, 3780890 207.00 How does negative interest rates policy work? BY REUTERS | SEP 13, 20:9, 0729 MIST LONDON: The European Central Bank doubled down on its negative rate policy on Thursday, meaning banks will now have to pay 0.5% interest simply for depositing much of their spare cash with it- an attempt to make them lend more to kickstart the economy. ig Change: Pon While such a policy is widely considered valid only for economies in Europe and Japan with chronically low inflation and weak growth, the idea is attracting other supporters elsewhere - not least U.S. President Donald Trump, who has labelled U.S. central bankers "boneheads" for not resorting toi This is how a negative rate policy works alongside some ofits potential pitfalls: WHY HAVE SOME CENTRAL BANKS ADOPTED NEGATIVE RATES? To battle the global financial crisis triggered by the collapse of Lehman Brothers in 2008, many central banks cut interest rates near zero. A decade late, interest rates remain low in most countries due to subdued economic growth. With litle room to cut rates further, some major central banks have resorted to unconventional policy measures, including a negative rate policy. The euro area, Switzerland, Denmark, Sweden and Japan have allowed rates to fal to slightly below zero, HOW DOES IT WORK? Under a negative rate policy financial institutions are required to pay interest for parking excess reserves with the central bank. That, ‘any surplus cash beyond that which regulators say banks must keep on hand, That way, central banks penalise financial institutions for holding on to cash in the hope of prompting them to boost lending to businesses and consumers. ‘The ECB introduced negative rates in June 2014, lowering its deposit rate to -0.1% to stimulate the economy. Describing the eure zone economy as mited in a period of protracted” weakness, ECB chief Mario Draghi announced on Thursday @ 10-basis-point cut in the deposit rate to-0.5% from is previous -0.4% The Bank of Japan (BOJ) adopted negative rates in January 2016, mostly to prevent an unwelcome strenghtening of the yen from hurting an export-reiant economy. It charges 0.1% interest on a portion of excess reserves financial institutions park with the BOJ. WHAT ARE THE PROS, CONS? Aside from lowering borrowing costs, advocates of negative rates say they help weaken a countrys currency by making it @ less atractve investment than other currencies. A weaker currency gives a country’s export a competitive advantage and boosts inflation by pushing up import costs. This is one of Trump's motivations for wanting negative rates on the dollar, Negative central bank rates also lower borrowing costs on a whole range of instruments, meaning that businesses and households get ‘even cheaper loans. But nogative rates also narrow the margin that financial institutions earn from lending. If prolonged ultra-low rates hurt the health of financial institutions too much, they could stop lending and damage the economy. ‘There are also limits to how deep central banks can push rates into negative territory - depositors can avoid being charged negative rates on their bank deposits by choosing to store actual banknotes instead. WHAT ARE CENTRAL BANKS DOING TO MITIGATE THE SIDE-EFFECTS? The BOJ adopts a so-called "tored” system under which it charges 0.1% interest only to a small portion of excess reserves financial institutions deposit with the central bank. It applies a zero or +0,1% interest rate to the rest of the reserves, ‘The ECB has a diferent system of tiring, inspired by one used by the Swiss National Bank, under which a portion of bank deposits, currently set at sic times their mandatory reserves, is exempted from the charge. hitpsileconamicimes inditimes.commarketsistocksinews/now-does-negative-nterest-rates-poicy-worklprntarile/71115451.oms 1270912019 How does negative interest rates policy work? - The Economic Times Yet citics point out that the exemption wil result in an annual saving of only 2-3 billion euros for the entire euro zone banking system. That equals only about 1% of these banks profits last year. Moreover, as excess liquidity is concentrated at larger banks in richer countries such as Germany and France, the scheme will not beneft all banks equally. Ths risks exposing barely concealed poltical divisions between euro zone policymakers. Just this weak, the Dutch parliament, ignoring the convention that central banks should be free from political pressures, wrote to ECB President Draghito tell him it opposed a “tiered” rate system because it could harm Dutch penion funds, While on Friday, Mass-seling German newspaper Bild accused Draghi of "sucking dry the bank accounts of Germany's savers with nogative rates. Stay on top of bust hitpsileconamicimes.inditimes.commarketsistocksinews/now-does-negative-nterest-rates-policy-worklprntarile/71115451.oms 2