Banking on the business of negative interest rates

Columnist

Thursday 28 February 2013

Imagine being asked to pay your bank for the privilege of depositing your money in it.

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Iain MacWhirter

Most of us think we are victims of reverse bank robbery already. But actually give them money to take our money? The Bank of England moved rapidly yesterday to insist the policy of negative interest rates, floated by bank official Paul Tucker, was "very blue sky thinking" and, anyway, wouldn't affect the deposit rate that is paid to ordinary savers, only big banks. Though, as we'll see, that isn't strictly true.

The main reason the Bank of England is talking about negative interest rates is to force the banks to lend to business. Much of that quantitative easing money that is being printed and handed, effectively, to the commercial banks is being redeposited with the Bank of England. Yes, the banks get electronic money from the Bank of England; then they deposit it back with the Bank of England to earn interest on the cash it has printed. You might think that is the economics of the mad house, and you might well be right. But in the paradoxical world of high finance, this is considered a sound monetary policy. It is also an insight into how banks made their money in the first place. Traditionally, bankers would borrow money in the morning from the Bank of England at 3% interest, and then loan it out after lunch to mortgage borrowers at 6%, and make it to the golf course by 4pm. What happened before the banking crisis was that the banks got greedier and started selling collateralised debt obligations and toxic mortgages after 4pm instead of playing golf. After the crash the banks were insolvent – ie bust – and we had to bail them out with public money. Now they don't want to lend to anyone if they can possibly avoid it – especially to businesses in a recession. They will lend mortgages to homeowners who can afford big deposits because the house is collateral for the loan. But lending to businesses means actually taking a degree of risk it won't be paid back. Whoa, they're not going to do that, are they? Why bother lending when you can earn interest on it with no risk by sticking it in the Bank of England. On £1 billion, even at 0.5%, the banks are making £5 million, which will at least keep the bonus pool topped up. So, to recap: the Bank of England is printing money for banks to deposit it back to them. Some of those bright chaps in Threadneedle Street eventually noticed this was happening and decided it didn't look quite right. So they want to say to the banks: "We will charge you for depositing your money (which is actually our printed money) with us to encourage you to lend it to small businesses". This will test the credibility of the bankers' excuse that they haven't been lending to business because there is no demand for it. It will also lead to cheaper mortgages because banks will have an incentive to lend more of it to home buyers. Mind you, I wouldn't hold my breath.The Bank of England insists it wouldn't directly lower interest on ordinary people's bank savings because these negative interest rates would only be for the banks. But this is not quite telling it straight. The banks, awash with printed cash, are not going to be particularly interested in getting more deposits in, so they are likely to lower the interest rates they offer to savers. (Lower, you snort, since most people with savings are lucky to get any interest at all.) Secondly, the banks can impose their own sneaky negative interest rate by upping the charges paid by depositors. (Upping, you snort again, isn't that what they've been doing already?) Now, you might ask, if all this free money is being given away, why can't we all have some? And there are economists and bankers who have suggested this, including Ben Bernanke, the boss of the US Federal Reserve. He once proposed dropping millions of dollars from helicopters onto cities to encourage people to go out and buy things. Ever since he has been referred to in financial circles as Helicopter Ben. The problem he was trying to address was the reluctance of people to spend in a recession – our old friend, the paradox of thrift.As Keynes noted, if everyone saves money at the same time (as they are inclined to do in an economic crisis) there is less cash in the system to buy goods in the shops. Factories therefore reduce output, shed workers and the cycle continues. His solution was for the Government to start spending on public projects to bolster effective demand in the economy. It's a different way of dropping money. Yet another way would be to give vouchers to unemployed people to buy stuff. This has been done in countries like Japan, where in 1999 the Government distributed $6bn to the elderly and unemployed. The problem with what we are doing now, which is stuffing the banks with printed cash and bolstering executive bonuses, is that rich people don't spend windfalls – they either buy expensive houses in London, speculate on stocks, or just save it. To keep money going round the best thing to do is give it to people who don't already have money, because they will go out directly and buy food and clothes for their families. But giving money to anyone other than bankers is thought to be morally corrosive and a disincentive to work. It is only in the magical world of banking that money can be invented and distributed by banks to banks. Also, the Government would have to borrow more, or print more money to give it away. There is a penalty to all this money printing, and we all know what it is: inflation. What the Bank of England is doing is trying to reduce Government debt by all means possible including allowing inflation to rise. Which brings us to the punchline of this whole story. Because the truth is, as anyone with a bank deposit knows, we already have negative interest rates. With inflation at 3% and interest rates at 0.5% you do the maths.

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Banking on the business of negative interest rates

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