All you want to know about negative interest rates.
Central banks are cutting rates dramatically to spur growth, but the move is not without its side effects.
Last week, a little known Danish bank, Jyske Bank, made news around the world by introducing 10-year home loans at a negative interest rate of 0.5 percent. How does that work? What led to this situation? To know that and more, continue reading:
What’s a negative interest rate?
One of the hallowed tenets of finance is that borrowers pay interest to lenders. A negative interest rate means that the lender is paying money to the borrower. Or look at it another way, a bank pays you interest on deposits in the normal course of affairs. But in a negative interest rate regime, instead of receiving interest, you are paying the bank to keep your money with it.
Is Denmark alone in having negative interest rates?
No, the world over, around $17 trillion of debt around the world have negative yields (or interest rates). In many countries across Europe and Japan, negative interest rates have been prevailing for some time.
What led to this?
The fall in interest rates below zero is the result of central banks trying to boost consumption (and inflation) and thus spark an economic revival. This started in the aftermath of the Global Financial Crisis of 2007-08. Central bankers thought that if they make interest rates low enough, it will make people stop saving and start spending. The European Central Bank cut its deposit rate to below zero levels in 2014, Japan followed soon after. At that time, central banks also started purchasing long term bonds from the market.
How do low or negative interest rates help?
There are two channels through which this works. One, it lowers borrowing costs as mentioned earlier. Second, when a country’s bonds yield negative returns, there is low demand for them.
Surely, there are some side-effects of this?
Yes. Negative interest rates disincentives savings because the central bank wants to promote spending. Banks can find it hard to make profits. That’s because while they may have to pay borrowers (like in the example of Jyske Bank earlier) to borrow, they may not find it easy to charge depositors for keeping money with them.
What happens if negative bond yields aren’t enough to boost economic growth?
Well, it would be up to governments to boost the economy by increasing spending. That is known as a fiscal stimulus. But as we have seen in India, governments might not be in a position to increase spending because their debt might be high or their deficits out of control.
How soon is India close to negative interest rates?
India is far away from even contemplating such a scenario. Note that the 10-year government bond yields upwards of 6 percent. True, the Reserve Bank of India has been reducing its policy rates in order to push bank credit and increase spending. But remember that inflation in India is still around 4 percent.
So, why should I care about negative interest rates in foreign countries?
As mentioned earlier, Indian interest rates are high compared to the rest of the world. This makes them more attractive to foreign investors provided the rupee doesn’t depreciate. We have already seen evidence of this by the increasing purchases of government and corporate debt by foreign investors.
source by money control
Last week, a little known Danish bank, Jyske Bank, made news around the world by introducing 10-year home loans at a negative interest rate of 0.5 percent. How does that work? What led to this situation? To know that and more, continue reading:
One of the hallowed tenets of finance is that borrowers pay interest to lenders. A negative interest rate means that the lender is paying money to the borrower. Or look at it another way, a bank pays you interest on deposits in the normal course of affairs. But in a negative interest rate regime, instead of receiving interest, you are paying the bank to keep your money with it.
Is Denmark alone in having negative interest rates?
No, the world over, around $17 trillion of debt around the world have negative yields (or interest rates). In many countries across Europe and Japan, negative interest rates have been prevailing for some time.
What led to this?
The fall in interest rates below zero is the result of central banks trying to boost consumption (and inflation) and thus spark an economic revival. This started in the aftermath of the Global Financial Crisis of 2007-08. Central bankers thought that if they make interest rates low enough, it will make people stop saving and start spending. The European Central Bank cut its deposit rate to below zero levels in 2014, Japan followed soon after. At that time, central banks also started purchasing long term bonds from the market.
How do low or negative interest rates help?
There are two channels through which this works. One, it lowers borrowing costs as mentioned earlier. Second, when a country’s bonds yield negative returns, there is low demand for them.
Surely, there are some side-effects of this?
Yes. Negative interest rates disincentives savings because the central bank wants to promote spending. Banks can find it hard to make profits. That’s because while they may have to pay borrowers (like in the example of Jyske Bank earlier) to borrow, they may not find it easy to charge depositors for keeping money with them.
What happens if negative bond yields aren’t enough to boost economic growth?
Well, it would be up to governments to boost the economy by increasing spending. That is known as a fiscal stimulus. But as we have seen in India, governments might not be in a position to increase spending because their debt might be high or their deficits out of control.
How soon is India close to negative interest rates?
India is far away from even contemplating such a scenario. Note that the 10-year government bond yields upwards of 6 percent. True, the Reserve Bank of India has been reducing its policy rates in order to push bank credit and increase spending. But remember that inflation in India is still around 4 percent.
So, why should I care about negative interest rates in foreign countries?
As mentioned earlier, Indian interest rates are high compared to the rest of the world. This makes them more attractive to foreign investors provided the rupee doesn’t depreciate. We have already seen evidence of this by the increasing purchases of government and corporate debt by foreign investors.
source by money control
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