Bank for International Settlements warns of negative rates risk

Despite exceptionally easy monetary conditions, in key jurisdictions growth has been disappointing and inflation has remained stubbornly low, economists from the Bank for International Settlements (BIS) have warned. "Market participants have taken notice and their confidence in central banks’ healing powers has, probably for the first time, been faltering", said Claudio Borio, head of the BIS monetary and economics department. 

The BIS published research on Sunday which cautioned that it was difficult to predict how individuals or financial institutions would behave if rates were to fall further below zero or stay negative for a long period. While central banks’ negative rates had impacted borrowing costs in the money markets that banks use to fund themselves, they were yet to affect businesses and households in the way that normal cuts would. It was unknown, the BIS said, how borrowers and savers would react or whether the channels through which central banks’ rate moves are usually passed on to the broader economy would “continue to operate as in the past”.

Four central banks had at least one policy rate below zero at the end of 2015. The ECB and the central banks of Denmark, Sweden and Switzerland (the Bank of Japan adopted a negative rate for a portion of bank reserves in January this year). In implementing negative rates, central banks have attempted to introduce them in ways that mitigate the burden on banks. For example, three of the four (all except Sweden’s Riksbank) applied negative rates only to bank reserves at the central bank that exceeded given thresholds.  

The latest turbulence, BIS remarks, has hammered home the message that central banks have been overburdened for far too long post-crisis, even as fiscal space has been dwindling and structural measures lacking. The policy could have serious consequences for the financial sector. "The vision of a future with even lower interest rates, well beyond the horizon, could cripple banks’ margins, profitability and resilience. Anxiety grew and spread following the Bank of Japan’s decision to adopt negative policy rates. At its peak, more than USD 6.5 trillion worth of sovereign paper was trading at negative yields – stretching once more the boundaries of the unthinkable", the research stated.