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ET in the classroom: Reading into negative rate trend

Many central banks around the world announced ultra low or even negative interest rates to help revive their respective economies post the financial crisis of 2008. ET takes a look at the scenario
1.What are negative interest rates? 


It’s an unconventional desperate monetary policy tool to prevent an economy from falling in a deflationary tool and incentivise borrowings by offering them discount on interest rate. The overall objective has been to raise economic growth and counter deflationary conditions by deterring saving, and encouraging borrowing and risk-taking.

2.How does such a policy work?
To give an example, if interest rate is positive 2%, and one borrows `100 from a bank, then the borrower pays back `102 at the time of repayment and the amount also includes the interest. But in case of negative interest rate, the borrower pays back only `98 at the time of repayment.

The bank on its part will also get funds at a discount from the central bank. Also, if it accepts deposits then even depositors are also charged for parking funds with a bank in a negative interest rate scenario.

  1. Which economies have negative interest rates?

    Many European central banks, including the European Central Bank, the Swedish and the central bank of Denmark, have introduced negative interest rates in an attempt to incentivise borrowing for productive activities and revive their economies. Most of them have introduced such rates in the period after the global financial crisis of 2008. More recently, Bank of Japan has introduced negative interest rates.

4. What is the flip side of such a policy?

Banks may choose to borrow less from the central bank in order to lower excess reserves and avoid the negative deposit rate. This would put upward pressure on rates in the interbank and bond market, offsetting the stimulative impact of the negative policy rate.

Second, even if negative interest rates are transmitted to money markets, retail deposits may remain insulated due to banks’ reluctance to pass it on to to depositors for fear of losing deposits, according to a Reserve Bank of India analysis. Also, if persisted for long, negative interest rates may encourage financial excesses, including instruments that emulate currency, allow tax avoidance and undermine the policy itself.

5.Are there any instances of adverse impact of such a policy?

There could be offsetting adjustment in lending rates among sectors, according to RBI. It cites the example of Swiss National Bank, where negative rates have led to a rise in mortgage rates to protect margins.

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