The BoE’s August Monetary Report notes if rates turn negative then deposit-taking institutions probably can’t take deposit rates below zero in response as customers would hoard physical cash.
As a result, the profit margins the banks make on the spreads between lending and deposit rates could narrow the most yet in the current rate-cutting cycle.
Virgin Money’s net interest margin in the UK fell 16 basis points over the June quarter to just 1.47 per cent.
Broker Bell Potter cut its valuation on the bank 10 per cent to $1.80, suggesting if UK cash rates go lower then it’ll struggle to reprice its savings rates offered to depositors.
Banks most reliant on retail deposits for funding are the most exposed to negative rates, according to the BoE. Bell Potter reported 79 per cent of Virgin Money’s funding came from retail deposits in the second half of financial 2020.
The BoE also noted academic research suggests that in countries or regions like Sweden, Denmark, and the Eurozone where rates have turned negative, banks have generally passed on lending rate cuts, but shied away from taking deposit rates below zero.
Crazy as it sounds, in August 2019, Denmark’s third-largest bank, Jyske Bank, reportedly became the first European bank to offer home loans between 10 to 20 years with zero interest or a negative 0.5 per cent rate.
The BoE has also acknowledged that if it turns to negative rates to fight COVID-19, British banks will suffer further as mortgage lending could even become unprofitable.
Australian monetary policy
In a speech made on Tuesday, deputy Reserve Bank governor Guy Debelle said negative rates were among four untried options available to help reach mandated inflation targets, although he was unconvinced such a policy is appropriate in the Australian economy.
The other three options were to buy more longer-dated bonds, FX market intervention to lower the dollar, or benchmark rate cuts without going negative.
Dr Debelle said the Reserve Bank believed the empirical evidence on negative rates is mixed, with evidence that their medium-term effectiveness can wane due to their effect on the financial system.
Westpac’s chief economist Bill Evans and RBC Capital economist Su-Lin Ong have said negative rates are possible in the next 12 months in the event of a second wave of COVID-19.
Reserve Bank governor Philip Lowe labelled the chances of negative rates as “extraordinarily unlikely” in June.
On the fiscal front the Australian government will raise $240 billion this financial year to pay for its $289 billion in fiscal and balance sheet coronavirus support for households.
It issued $15 billion of 30-year bonds at a rate of 1.94 per cent in late July.
Inflation is still running well below 1.94 per cent at 1.2 per cent based on the RBA’s preferred trimmed-mean measure for the June quarter.
The lesson from the latest falls in global bank shares is that the immense pressure to stoke inflation above governments’ long-term borrowing rates to cheapen the debt means rates, and bank shares, could yet take another leg lower.