Beware of knock-on effects

It is not a matter of why central banks are charging for deposits, but why it is a step backwards and what happens should our three leading local banks impose negative interest rates ("Why are central banks charging for deposits?"; Feb 13).

People may not be aware of the consequences of negative interest rates. Essentially, it is when the banks start charging you to handle your money. No more free current account transactions, for instance.

If interest rates go deeper into negative territory, the banks' profit margins will be squeezed harder, and that will lead to lower profits and, eventually, to erosion of capital.

And if banks are not profitable, they are less able to add to the capital buffers that allow them to operate safely. This will put pressure on them to charge their own customers for deposits.

Such pressure is already starting to be felt. Banks in Europe have started to pass on some of the costs of negative rates to big corporate depositors. Their only ready alternative to stashing large pots of cash is safe and liquid government bonds, whose yields have also turned negative.

Retail customers will become more resistant to charges because small stashes of cash can easily be stored in a mattress or a home safe.

Savers might stomach a modest fee for making bank deposits but as rates go deeper into negative territory, they will find ways to avoid charges. For example, small savers will use any available form of prepayment, such as gift vouchers, long-term subscriptions, transport cards or mobile phone SIM cards, to avoid the cost of having money in the bank.

If the negative interest rate environment is sustained, specialist security firms may emerge and they will build vaults to store cash on behalf of big depositors and manage transfers between their customers' accounts.

Firms will also seek to make payments quickly and receive them slowly. Government agencies may even discourage prompt settlement or overpayment of accounts.

Far from being incentivised to extend credit, banks will be more worried about shrinking deposits if people avoid depositing their money.

Negative interest rates may send investors in search of better returns abroad, leading to a depreciation of currency and hurting our exports and outflow of capital.

Negative rates will risk creating a crisis impression and, thus, lower discretionary spending and monetary velocity.

All these will lead to greater uncertainty and a new normal never before seen in Singapore financial history.

Francis Cheng

A version of this article appeared in the print edition of The Straits Times on March 07, 2016, with the headline 'Beware of knock-on effects'. Print Edition | Subscribe