How banks can ease the pain of negative interest rates

With better governance and data collection, treasurers can staunch the effects of margin erosion.

 
By significantly reducing interest rates, central banks in Europe, Japan, and the United States have sought to stimulate economic activity, stabilize banking systems suffering from nonperforming loans, and manage exchange rates. A few have even pushed reference rates toward zero and below, while also undertaking quantitative easing in the form of bond-buying programs, to push down term rates as well. Against this background, central banks are contemplating broader and more intensive implementation of negative rates in case of a severe downturn.

While economies have benefited, low and negative interest rates come with strong side effects for investors and financial institutions. Over time, negative interest rates hurt profitability by eroding banks’ net-interest margins. Japanese banks, for example, first saw net-interest margins increase as client rates on deposits were reduced faster than average rates on loans.1 Soon thereafter, however, net-interest margins steadily declined as yields on loans and bonds acquired declined, pushed down by the Bank of Japan’s quantitative-easing program. The increase in balance-sheet volumes did not offset the decline in net-interest margins.

Economists and business analysts expect that the present squeeze on margins is going to last at least five years, and probably more. Eurozone banks could face a margin decline of eight basis points. But there’s good news too: treasurers may be able to mitigate most or all of the forecast depletion, through a combination of effective governance, a clear risk-appetite framework for hedging strategies, and IT and data reporting that achieves transaction-level transparency.

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