Negative Interest Rates

Since the financial crisis of 2008, some advanced economies have been struck with low growth, investment and inflation. In an attempt to regain growth, central banks of some of these economies have resorted to bold monetary policies, one of which is the negative interest rate.

The following table shows some policy rates of the countries which have negative interest rates or zero interest rates over the last few years.

Countries 2014 2015 2016 2017 2018
Denmark -0.05% -0.75% -0.65% -0.65% -0.65%
Euro Area 0.05% 0.05% 0% 0% 0%
Japan - - -0.1% -0.1% -0.1%
Sweden 0% -0.35% -0.5% -0.5% -0.5%
Switzerland -0.25% -0.75% -0.75% -0.75% -0.75%

The idea of negative interest rates is as follows: commercial banks hold bank deposits with central banks. The central banks pay a small interest on these deposits to the commercial banks. Over the years, the interest rates that the central banks were paying to the commercial bank has come down drastically. Even though the rates are unattractive and possibly not financially prudent for the commercial banks, they continue to hold these deposits, as they feel that their money is safe with central bank than if they were to give loans to corporates and individuals. Since their economies are not doing good, they fear that commercial loans may end up being bad loans; thus, a safer deposit with central bank is better than a commercial loan.

The governments and central banks fear that such behaviour of the banks is adding to the problem of low growth. In an effort to induce the commercial banks to provide more loans to households and businesses, some central banks started experimenting with negative interest rates. Under this concept, the central banks will not pay any interest on the deposits held by the commercial banks, instead they will charge a small fee for holding such deposit. This is done by simply making interest rates negative. For example, a 2% interest rate means that the central bank will pay 2% per annum to the commercial banks on their deposits. A -2% means that the central bank will not pay any interest on the deposits held by the commercial banks, instead, it will charge 2% for holding the money of commercial banks. A positive interest rate is an earning for a commercial bank, while a negative interest rate becomes a charge for it. The idea is that it would discourage the commercial banks to keep balances with the central bank and force them to lend more to households and businesses, which may help in improving investments and thereby growth of their economies.

Which sectors are affected?
A reduction of interest rates in the interbank market and the market between the central banks and the commercial banks is designed to affect the end consumers – i.e. retail consumers and corporates.

For deposits (both retail and corporates), it would mean a reduction in the interest they get on their deposits with banks, as the banks would pass on the charge to them. Such reduction may induce retail savers to spend, thereby increasing demand for goods and services in the economy. It is also possible they may not spend and instead seek to invest in other securities that give better returns, such as corporate bonds and equities. This too may be beneficial as the increase in demand for these securities will decrease their yields on existing securities, and also the new cheap money may attract new entrepreneurs and existing businesses to issue new securities – both equity and bonds – which will help in creating investments and jobs.

For borrowers (both retail and corporates), it would mean a reduction in the borrowing costs. For retail borrowers, it would mean cheaper mortgage loans, educational loans, consumer durable loans, etc. This may help increase demand in the economy. For corporate borrowers, this means lower funding costs for their existing and new projects, which will encourage them to invest, creating jobs and growth opportunities.

Negative interest rates and cash holding
Throughout history, it was widely believed that central banks could not move short-term interest rates below zero. After all, why would anyone pay to deposit money in a bank or pay to lend someone money, when they could just keep their cash at home for free. Cash always has zero interest rate.

It was believed that if interest rates did dip below zero, even by a very small amount, everyone with savings would run to the bank to change them for ready cash. The zero-interest rate on cash was seen as the lowest point an interest rate could dip to, the point at which central banks would be out of ammunition.

When central banks started dropping interest rates to below zero without adopting any measures to make cash costly to hold, it changed the prevailing world view. Zero was no longer the lower bound on interest rates. It turned out that many were actually willing to pay for the convenience of not having to hold their savings in cash. For corporates, this was not unusual as they are used to the concept of not getting any interest on their checking and current accounts, instead they always paid charges on it.

The example of Switzerland suggests that interest rates can go at least as low as -0.75% without triggering a large demand for cash. But we do not know yet where the bottom is.

The Plan
The plan of the central bank is to increase economic activity and spur inflation from the low or even deflationary levels that some countries are currently in danger of. The following are ways in which this can happen.
  1. Banks can lend more to households and companies, rather than holding on to cash, which has now become costly.
  2. Businesses can invest more, as funding investments is now cheaper.
  3. Households could save less or borrow to spend more.
  4. Demand for the currency could fall. This might lead to a depreciation of the currency, an increase in the price of imported goods and growing demand for the country’s cheaper exports.

Concerns about the plan
The following are some of the concerns of this plan.

Which interest rates are we referring to when we say, Negative Interest Rates?
At any instance, there are many interest rates in an economy, such as the following.

Rates used by central banks Rates on government securities Rates used between banks
Rates between banks and their customers Other rates
In general, we say that interest rates are increasing or decreasing, and we may probably be implying that all the rates are moving in the same direction, if not in the same proportion. While this is fine for casual and general discussion, in real, the rates do not move in tandem or even in the same direction. A reduction in one rate may not result in the reduction of other or vice-versa. In fact, it is quite possible that the rates may move against each other in certain circumstances.

Of all the rates, the rates used by the central bank are the most important as they set the benchmark for the other rates in the economy. When referring to negative interest rates, in our discussion on the topic, we shall refer to the interest rates on reserves, borrowing and lending set by the central banks. These rates are commonly referred to as “Policy Rates”, which are explained in detail later in this reading material.

With reference to negative interest rates, not all these rates have been made negative by the countries adopting “Negative Interest Rate Policy (NIRP)”. Some countries have made the repo rates negative, while others have made the deposit rates negative, depending on their individual circumstance. The following table shows as to which rates are made negative under the NIRP policy.

Country Interest Rate Description Rate
Denmark Certificate of deposit rate -0.75%
Euro Area Deposit rate -0.5%
Japan Repo rate -0.1
Deposit rate -0.1%
Sweden Repo rate -0.25%
Deposit rate -1%
Switzerland Repo rate -0.75%
SNB Bills rate -0.75%

Which countries have negative interest rates?
The central banks of the following countries have implemented negative interest rates as part of their monetary policy.
  1. Euro Area
  2. Sweden
  3. Denmark
  4. Switzerland
  5. Norway
  6. Bulgaria
  7. Japan
  8. Hungary
  9. Bosnia and Herzegovina
The following section addresses the reasons behind implementation of NIRP policy in these countries.

Euro Area
In May 2014, the European Central Bank (ECB) set off the move into negative interest rate territory by lowering its deposit rate sufficiently to pull the interbank overnight rate below zero. The main reason for ECB to do this is to stimulate economic growth and raise inflation.

Since the global financial crisis, the ECB has been trying various methods to stimulate growth and pull the European union out of possible recession. From 2015 to 2018, it did quantitative easing by introducing about 2.520 trillion euros. The Picture-1 below shows the Euro Area Central Bank Balance Sheet, which has expanded significantly since the financial crisis of 2008.

Picture-1: Euro Area Central Bank Balance Sheet
ECB Balance Sheet

These measures, though partly successful in the short run, seem to be insufficient to get the economies on track in the long run. Demand and investments have stagnated, and growth rates are unsustainable due to global and local factors. Despite all measures, the inflation was stubbornly low. The NIRP was one of the last few desperate moves by the ECB to set things right.

Commercial banks are subjected to a minimum reserve requirement under ECB (also commonly called as “Cash Reserve Ratio (CRR)”). The CRR rate under ECB is 1% of net term and demand liabilities. On the minimum CRR balances, a zero percent rate is applied. On reserve balances exceeding the minimum CRR rate, a negative interest rate is applied. Thus, in the Euro Area, the negative interest rate is not applicable on all reserve balances but only on the excess reserves balances exceeding the minimum CRR ratio.

Following the ECB’s announcement of a negative deposit rate, the Swedish central bank, Sveriges Riksbank (SR), implemented a negative deposit rate in July 2014 to tackle subdued inflation rates and exchange rate stability.

Negative interest rates are not new in Sweden. The deposit rates had been in negative during 2009 and 2010.

Like other developed countries, Sweden too employed quantitative easing as a tool to stimulate economic growth post the Global Financial Crisis (GFC). Due to the quantitative easing, the balance sheet of its central bank expanded post GFC. Notably, its central bank resorted to foreign exchange intervention to ensure that its currency did not appreciate too much against Euro and other major currencies. The result of this is that a large portion of its central bank’s assets consist foreign exchange reserves, as can be seen in the figure below.

Picture-2: Sweden's Central Bank Balance Sheet

Sweden's Central Bank Balance Sheet

Denmark had to adopt a NIRP policy due to its currency peg to Euro. Currently, Denmark is the only member of the European Exchange Rate Mechanism II (ERM II) system. Under the system, the Danish Krone is pegged to the Euro at a central rate of 7.46038 to the Euro with a narrow fluctuation of +/- 2.25% (official range is +/- 15%). The central bank of Denmark (Danmarks Nationalbank) has absorbed increasing amounts of foreign financial inflows on its balance sheet due to this currency peg. It is this accumulation of foreign reserves and associated exchange rate pressures that the adoption of NIRP was to address.

If interest rates were not reduced in Denmark, funds would have flown from other countries into Denmark, which would have resulted in appreciation of DKK. The large-scale sale of DKK (Danish Krone) and purchase of foreign currencies ensures that the exchange peg is maintained, and the currency is not appreciating.

The following picture shows the Denmark central bank’s balance sheet which has a large portion of foreign currency assets.

Picture-3: Denmark's Central Bank Balance Sheet

Denmarks's Central Bank Balance Sheet

The adoption of a NIRP by the ECB was also followed by renewed pressure on the Swiss Franc peg to the Euro. To relieve pressure from financial inflows and maintain the peg, the Swiss National Bank (SNB) followed Denmark into negative territory on 18th December 2014 by lowering all of its available policy rates and interest targets below zero.

Together with the adoption of the NIRP, the SNB also created a new facility for domestic commercial bank reserves, known as “Sight Deposits”. Negative interest rates are applicable on these sight deposits. Currently, the interest rate on these sight deposits is -0.75%, same as the repo rate interest.

The negative interest rate is not applicable on all the reserve balances. The SNB adopted a tiered reserve system, wherein negative interest rate is applicable only on excess balances; the minimum required balances will attract zero interest.

As discussed, the adoption of NIRP meant that the SNB had to intervene in the foreign exchange market to stabilize the Swiss Franc. This has expanded its balance sheet, which now has a sizeable portion of foreign reserves. The following picture shows the balance sheet of SNB.

Picture-4: Switzerland's Central Bank Balance Sheet

Switzerland's Central Bank Balance Sheet

Norway did not explicitly adopt a NIRP. The Norwegian Central Bank (Norges Bank) lowered its reserve rate below zero in September 2015 for the purposes of exchange rate stability. Similar to the tiered-reserve system adopted by other countries, Norges Bank adopted the NIRP only on the excess reserve holdings. The minimum reserve holdings are subjected to normal interest rates.

Norges Bank adopts has three rates, namely 1) Key policy rate, 2) Reserve rate, and 3) Overnight lending rate.

The key policy rate is the main instrument for stabilising inflation and developments in the Norwegian economy. The policy rate is the interest rate on bank’s overnight deposits in Norges Bank up to a specified quota. The policy rate and policy rate expectations primarily influence interbank rates and bank’s interest rates on customer deposits and loans. The key policy rate is also referred to as the “Sight deposit rate”.

The Reserve Rate is the rate on the central bank’s marginal deposit facility. The reserve rate is intended to give banks an incentive to redistribute reserves among banks.

The overnight lending rate, as the name suggests, is the rate charged by Norges Bank on overnight lending to its commercial banks. It has no monetary policy function, and any changes to it does not imply any changes to the key policy rate. Currently, the overnight lending rate is set 1% more than the key policy rate.

All the rates used by Norges Bank are unsecured rates.

The following graph shows these rates since 2008.

Norges Bank Rates
Source: Norges Bank

The central bank has not intervened in the foreign exchange market since January 1999 but manages the foreign reserve holdings of Norway’s pension fund and foreign exchange revenues accruing from petroleum sales. Thus, a substantial portion of its balance sheet contains foreign reserves, as can be seen below in the diagram.

Picture-5: Norway's Central Bank Balance Sheet

Norway's Central Bank Balance Sheet

Since 1997, Bulgaria has been operating under a currency board, which linked its currency (Bulgarian Lev) to the German Mark and later to the Euro. The Bulgarian National Bank (BNB) thus mirrors the ECB’s policy stance, despite not being a member of the Euro area or the ERM-II. Accordingly, it introduced a tiered-reserve system and the negative interest rates apply to the excess reserves only. Currently, the minimum reserve requirement is 10%. The negative interest rates on excess reserves equal that of the ECB’s deposit facility when the ECB’s deposit rate is negative, and zero when the ECB’s deposit rate is zero or positive.

Due to its currency interventions, its balance sheet expanded significantly since 1997 (its adoption of currency board). The following picture shows the composition of its balance sheet, where the foreign reserves as assets hold a predominant position.

Picture-6: Bulgaria's Central Bank Balance Sheet

Bulgaria's Central Bank Balance Sheet

The Bank of Japan (BoJ) adopted the NIRP on 29th January 2016 with the explicit goal of providing additional easing of monetary policy conditions and targeting inflation. Accordingly, the repo rate (called as Complementary Lending Facility in Japan) was set at -0.1%. This reduced the overnight call money market rate too.

Similar to other countries, the BOJ divides the reserves into types: 1) The positive rate basic balance (rate is 0.1% currently), 2) Zero rate “macro add-on” balance (rate is currently 0.1%, and 3) The negative rate “policy rate” (the rate is -0.1% currently). Since the bulk of the reserves is allocated to the first two tiers, the negative interest rate only applies to a fraction of bank reserves.

Japanese banks have experienced, a severe compression of lending margins since the introduction of the NIRP, as they have a structural surplus of deposits over loans and since there is little room for the deposit rate to decline even while lending rates are dropping, given the competition in the market.

The balance sheet structure of the Bank of Japan reflects the quantitative easing policy undertaken from 2001 to 20016 and thereafter from 2010 onwards. Under this policy, the Bank of Japan purchased about ¥166.3 trillion of Japanese government securities since 1997. The below balance sheet shows this aspect.

Picture-7: Japan's Central Bank Balance Sheet

Japan's Central Bank Balance Sheet

Subdued inflation and exchange rate figures prompted the Hungarian central bank, the Magyar Nemzeti Bank (MNB), to adopt a negative deposit rate on 22nd March 2016. The balance sheet of MNB expanded in size since the Global Financial Crisis, partly due to its currency interventions. The following picture shows the balance sheet of its central bank.

Picture-8: Hungary's Central Bank Balance Sheet

Hungary's Central Bank Balance Sheet

Bosnia and Herzegovina
Similar to Bulgaria, Bosnia and Herzegovina is also pegging its currency, the convertible mark, to the Euro within a currency board arrangement. As a consequence it had introduced a negative deposit rate equivalent to 50% on the rate on the ECB’s deposit facility in July 2016.

Unlike other banking systems, the interbank market is extremely low in the country, with no repo transactions and only a limited number of interbank overnight transactions taking place. The only tool at the disposal of its central bank to influence interbank liquidity is the reserve requirement, which currently stands at 10%. The negative interest rate applies to reserves exceeding this minimum reserve requirement ratio.

Reasons for Negative Interest Rates
As discussed earlier, the reasons for the implementation of NIRP differs from country to country. Summarily, the following are the reasons in each of the countries.

Country Reasons for implementation of NIRP
Euro Area Stimulate economic growth and raise inflation
Sweden Tackle inflation and exchange rate stability
Denmark Reduce financial inflows and exchange rate stability due to its peg
Switzerland Exchange rate stability
Norway Exchange rate stability
Bulgaria Exchange rate stability due to its peg under a currency board
Japan Easing of moneytary policy conditions and inflation
Hungary Exchange rate stability and to tackle subdued inflation
Bosnia and Herzegovina Exchange rate stability due to its peg under a currency board

Effects of negative interest rates on customers on bank
It is important to note that the term Negative Interest Rates here applies to the interbank borrowing market and the market between central banks and the commercial banks. Negative interest rates are not meant for dealings between banks and its customers (retail, corporate and institutions). The customers of bank may seldom experience negative interest rates. They may be affected by the negative interest rates if the commercial banks pass on the negative interest rates to them. For example, if a commercial bank is faced with a negative interest rate from its central bank, then it may reduce the interest rate that it pays to its depositors by a similar extent. The depositors, in this case, would be paying the charge to the central bank to a large extent, and the bank may shield itself from the impact. However, if the reduction were to be too steep, then the depositors may pull-off their funds from the bank and invest their money in better yielding securities.

Thus, one would expect that the negative rates are kept between the central banks and the commercial banks and passed on to the retail and commercial markets, but without them ever touching zero. However, recently, some banks have reduced the retail and commercial rates to below zero. Jyske Bank of Denmark became the first commercial bank in the world to reduce the interest rate on mortgages below zero. Its mortgage rate is -0.5% for a 10-year loan, 0% for a 20-year loan and 0.5% for a 30-year loan.

In essence, what it means is that if a home buyer takes a 10-year mortgage from Jyske Bank, it would not have to any interest at all. Jyske Bank will pay him 0.5% interest per annum for taking the loan. However, the bank does not pay cash to the customer. The customer will have to pay EMI every month and the bank will reduce the loan outstanding by -0.5% adjusted on a monthly basis. In real, the customer will not actually enjoy -0.5% interest rate as there would be bank charges and fees levied on the loan.

Jyske Bank may be the first bank but may not be the only one. Nordea bank is offering 0% interest on mortgages and may soon go below zero. On the retail front, Jyske Bank is offering zero interest on retail deposits.

Description of some of the policy rates

Repo Rates
It represents secured lending by the central bank to commercial banks. It is usually an overnight rate but term rates (usually for week or above) are also found. It is commonly referred to as the policy rate as the central banks use this rate for liquidity adjustment facility puroses. In some countries or areas, this rate is known in different names. For example, the European Central Bank calls it "Marginal Lending Facility Rate", the central bank of Denmark calls it as "Collateralized Lending". The following are the names by which this rate is referred to in some countries along with this current rate (Sep 2019 rate).

Country Name called Rate
India Repo Rate 5.4%
Denmark Collateralized lending rate 0.05%
Sweden Repo rate -0.25%
European Central Bank Main Refinancing Operations Rate (MRO rate) 0%
USA Repo Rate (Discount Rate or Primary Credit Rate) 3%
UK Repo Rate 4.5%
Switzerland Repo Rate -0.75%
Japan Complementary Lending Facility Rate -0.1%

Reverse Repo Rates
It represents secured borrowing by the central bank from commercial banks. It is usually an overnight rate but term rates (usually for week or above) are also possible. Some countries have reserve-repo rates, while others only have repo rates. The reverse repo rate is always less than the repo rate because the central bank would like to borrow at a lesser rate than it lends to the commercial banks. The following are the rates in some countries.

country Name Called Rate (Sep 2019)
India Reverse repo rate 5.15%
Denmark n.a. n.a.
Sweden n.a. n.a.
European Central Bank Reserve transactions or MRO rate 0%
USA Overnight Reverse Repurchase Rate (ON RPP rate) 2.2%
UK Repo rate 4.5%
Switzerland Reverse repo rate (same as repo rate) -0.75%
Japan n.a. n.a.

Deposit Rate
It is the interest rate paid by a central bank on funds maintained by the commercial banks with it. Commercial banks are required to maintain a certain percentage of their net demand and time liabilities with central banks. It is usually called as CRR Ratio (Cash Reserve Ratio). Some central banks pay interest on these deposits, while others do not pay any interest. Recently, some central banks have started charging interest on these deposits instead of paying interest.

The following are the CRR rates in various countries.
country CRR Rate
India 4%
Denmark No minimum reserve requirement (the account should not be negative)
Sweden No minimum reserve requirement (the account should not be negative)
European Central Bank 1%
USA 0% for liabilities beween $0 to $16.3 million
3% for liabilities more than $16.3 million and up to $124.2 million
10% fo liabilities of more than $124.2 million
UK No minimum reserve requirement
Switzerland 2.5% of relevant short-term liabilities + 20% of liabilities towards customers in the form of savings and investments.
Japan Between 1 to 2% (depends on type of deposit and volume)

The following table shows the CRR rates.
Country Name Called Rate (Sep 2019)
India CRR Interest Rate 0%
Denmark Current Account Rate 0%
Sweden Deposit Rate -1.0%
European Central Bank Deposit Rate -0.5%
USA Interest on required reserves (IORR rate) 2.1%
Interest on excess reserves (IOER rate) 2.1%
UK UK Bank Rate 0.75%
Switzerland - -
Japan Complementary Deposit Facility -0.1%

Lending Rate (Unsecured and overnight)
It is the interest rate received by a central bank on short-term unsecured lending to the commercial bank. It is usually an overnight rate. Some central banks provide secured loans only via overnight repos. The following are lending rates in Denmark and Sweden.

Country Name Called Rate (Sep 2019)
Denmark Lending rate 0.05%
Sweden Lending rate 0.5%

Marginal Lending Rate or Marginal Standing Facility Rate (Secured and Term lending)
Sometimes banks are allowed to borrow money from the central bank in excess of the quota granted under the liquidity adjustment facility. The central bank charges a higher interest rates on these borrowings than the repo rate.

Country Name Called Rate (Sep 2019)
India Marginal Standing Facility Rate 5.65%
European Central Bank Marginal Lending Rate Facility 0.25%
Japan - 2.3%

Discount Rate (Secured and overnight lending)
It is the rate at which the central bank discounts bills of the commercial banks. Usually, certain types of bills of exchange and commercial papers are discounted by the central bank. The following are some of rates.

Country Name Called Rate (Sep 2019)
USA Primary credit rate 2.75%
Secondary credit rate 3.25%
Seasonal credit rate 2.10%
Japan Basic loan rate 0.3%

Certificate of Deposit Rate (Unsecured and Term lending)
Usually, banks borrow short term money by issuing "certificate of deposit", and we do not associate this term to borrowing by central banks. However, some central banks use this term (Certificate of Deposit) to refer to its short-term unsecured borrowings. Usually, these borrowings are for a week or forthnight but seldom over that. For example, in Denmark "Certificate of Deposit" refers to the borrowings by its central bank for periods of one week or above. The following table shows some of these rates.

Country Name Called Rate (Sep 2019)
Denmark Certificate of Deposit -0.75%
USA Term Deposit Facility 2.2%
Switzerland SNB Bills -0.75%


Updation History
First updated on 22nd September 2019