In this article we will discuss the likely effects of prolonged negative interest rates, offered to consumers, by banks on all deposits.

We should note that negative interest rates, in the real world, for consumers are rare, so this piece only has a limited time of limited geographic exposure of examples to base claims on. Though the period in Europe lasted over a decade, there were differences between banks, also with brackets so not the entire deposit but a part of it was effectively charged interest. Most sources focus on corporate parties, whilst zooming in on financials.

Reasoning and effect of negative consumer interest rates

The primary reason why central banks start with negative interest rates, is to encourage banks to start lending and investing, instead of storing deposits. There are three reasons why this mostly fails or has a reduced effect:

1 Regulations force banks to hold bonds and a minimum amount of cash; thereby reducing what banks can lend and capping the return on part of their capital. The part that banks are allowed to lend, is also faced with regulation and standards. Therefor, some banks did not find themselves in the position to put a lot more of the liquid assets entrusted to them to work.

2 Most banks are reluctant to pass the effects on to their customers, resulting in a game of chicken: Whoever lowers their rates to below 0, is likely to see an outflow to those who did not blink. When the competition finally does blink, there is no such effect, as rates have already dropped. Instead of decreasing interest to the negative range; banks increased their fees. We did notice that they did not lower these fees when interest rates became positive once more.

3 Consumers are not as agile as policymakers (including economists) tend to believe they are. Depending on the country/culture, most people are highly reluctant to switch banks or take out loans beyond mortgages. Investing is something West European frown upon, because they are risk avers and have a savings culture: Reducing interest rates, for such a group, only widens the gap with other, less risk avers, groups.

The result of above reasons was that there never really came a big push to spending. Consumers simply do not have the ability to take out multiple loans (no bank will give you three mortgages, and student loans affect how much mortgage or any other loan you can have), or base their decisions on nothing else other than interest rates.

Corporate loans did increase, which is beyond the scope of this article.

Deposit amounts

No real surprise, deposits did drop, as people do not like losing money. We should note that long term deposits or foreign bank accounts could still offer a return, so a portion probably went overseas*. Naturally, increased banking fees and negative rates themselves also reduced bank deposits. A small surprise is that the reaction to interest rates is far bigger when negative, then in the positive areas: A large portion of people do not consider this a simple rate adjustment, but a game changer.

There are also arguments to expect more bank deposits; in case of expected economic downturns mostly. In such a case, people actually save more money to avoid trouble, as is standard in negative scenarios. In most cases, a higher interest rates is offered for fixed term deposits, usually 3 months to 5/10 years, with the longest period offering the highest rate, shorter periods can be lower than general savings account rate.

Shift to investing

There are some who start investing, to avoid losing money, but this effect is partial. A lot of people, in generally more conservative Europe, do not invest for lack of knowledge or inherit risk. The lack of knowledge can be fixed as most banks offer a fairly basic service. The inherit risk is something permanent, requiring a change in attitude and legislation: Some countries tax investing heavier than savings, offsetting some gains, or even exceeding them. Bonds definitely can offer returns below inflation+taxes+service fees. Savings are virtually guaranteed to be below those three combined costs.

Though the increase in investing does lead to higher valuations, benefitting the group that started before negative consumer interest rates. Newcomers, with limited knowledge, can only hope to avoid overpaying.

Spending

There is usually a increase in spending, though this depends on the situation. If deflation is expected, people will avoid spending, as price reductions are expected, potentially creating a deflationary spiral as people avoid buying whilst shop keepers keep reducing prices. If deflation is not expected, people will start spending fast, for the simple reason that not spending means losing money on the amount stored with banks.

A general rule could be that long term savings planned expenses are made reality as soon as possible (as not doing so is costly; larger savings amount, tended to fall in the worst negative interest brackets). Mid term plans are enacted virtually immediately, for saving no longer offered any advantage. Small savings goals are typically based on paycheques, so these remain largely unaffected. For those with difficulty in keeping their cheques deposited, negative rates offer an excuse to spend even more.

Long term development

One of the more frightful possibilities is that an entire generation grows up, thinking that saving is costly; besides inflation, you directly lose money by storing it in a bank account. Resulting in dropping deposits and a entire age group with a shopping habit; though good for short term growth, banks need money to support the economy via mortgages and such.

A prolonged period of reduced deposit interest rates, not negative but below inflation, negatively affects how much people can spend. Thereby reducing economic growth; we should note that banks will not lend below inflation, as they have to make a profit goal, above costs and deposit interest, that usually exceeds Central Banks inflation goal of 2%. This also creates a relatively large gap between rates offered and paid by consumers. At moment of writing, loans can charge over thrice the rate offered for long term deposits.

 

*Before doing so, calculate (or at least consider) the risks and expectancy for offsetting higher rates, with expected exchange rates and inflationary effects for relevant overseas countries/currencies. Should be noted that tax evasion could also be a reason for opening accounts anywhere else, which attracts attention to the capital movement, and a hurdle when filing tax return.