The impact of ‘negative rates’ on credit unions
While a Fed funds rate of less than zero is possible, its impact on actual earnings, capital and modeling seems not to warrant further action at this time.
Given the current low-rate environment, I’ve again been getting some questions on “negative rates” and the impact they would have on financial institutions, and more specifically interest rate risk modeling. We’ve all heard about negative rates in Japan and parts of Europe, so it would seem reasonable to wonder about the impact that negative rates could have here in the U.S.
Negative Rates for Assets and Liabilities
Let’s first review what we mean by “negative rates” and, perhaps more importantly, what we don’t mean. The conversation about “negative rates” is really in regard to the rate that a central bank (in the case of the U.S., the Federal Reserve Bank) charges individual banks to hold money at the Fed. If we all think back to Econ 101, we remember that interest rates are one of the main tools the Fed uses to adjust monetary policy. The Fed funds rate guides how individual banks and lenders then set their own rates. As such, the idea behind negative rates would be to disincentivize banks to hold cash at the Fed (or other correspondent banks) and instead drive them to lend it to potential borrowers. More simply put, the theory is that banks would rather lend the money to borrowers and earn at least some interest than be charged to hold their money at the Fed or in a correspondent account.
As previously noted, negative rate strategies have actually been employed in other countries. Sweden’s central bank was the first to deploy them in July 2009 when the Riksbank cut its overnight deposit rate to -0.25%. As this is written, the central banks in both Switzerland and Japan have negative rates (-0.75% and -0.10%, respectively). With that said, it’s important to highlight that here in the U.S., the Fed appears to remain against implementing negative rates as a tool to help stabilize the U.S. economy. Federal Reserve Chairman Jerome Powell has repeatedly said that negative rates are not something that will be implemented, though it is uncertain what, if any, impact the incoming administration will have on that position.
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