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How Negative Interest Rates Impacts Banks – A Quick Look At Danske Bank

How Negative Interest Rates Impacts Banks  – A Quick Look At Danske Bank By Sam Walker, Financial Markets Enthusiast, Contributor to investbrain.net

How Negative Interest Rates Impacts Banks  - A Quick Look At Danske Bank
Source: Pixabay

Negatives interest rates has been a popular topic in 2016 and a source of incremental consternation to the financial markets, particularly to banks both domestic and international. To understand what negative interest rates are, its important to understand the relationship between banks and financial institutions and central banks. Essentially every major bank in the United States keeps cash or cash equivalents at the central bank for which it earns interest income at a specific rate. This is capital that the bank could instead be lending out to businesses and individuals, ideally for better returns. So in order to stimulate lending activity, the central bank can reduce the rates it pays banks, to dis-incentivize them from keeping their capital at the central bank and encouraging them to increase lending. The low rate environment that’s existed since the financial crisis in the United States is a consequence of this policy. But when you’re already at near 0% interest rates and want to drive further stimulation, you have to go into the negative territory meaning banks now have to pay to store their capital at the central banks.

Danske Bank – Why Do Negative Interest Rates Matter?

Denmark for example cut its deposit rate below 0% in 2012, and it currently stands at -0.65%. The above chart shows a slide from Danske Bank, one of the largest banks in Europe and the largest in Denmark. The area to focus on is the red bar, “deposit margin” – this is what happens when you end up switching from earning interest on a portion of your capital to having to actually pay interest, your deposit margin becomes hugely negative. The consequence of this is reduced net interest income, and all else equal, lower earnings and returns. The adoption of negative rates by the EU and fear of Janet Yellen adopting a similar policy has led to widespread declines in financial stocks in 2016.