Wednesday, February 24, 2016

The impact of negative interest rates on the financial sector

Low interest rates have a negative effect on many financial institutions. Negative rates only make it worse and highlight some significant problems around the globe for financial services. It creates odd incentives and will destroy portions of the financial markets.

The poor economics of some of these businesses may lead to radical change in the financial industry. Money market fund and bond funds are not viable businesses and may do nothing for investors. What fee should pay in a negative rate environment. You are already being charged to hold the bonds. The guaranteed annuity business in many countries is gone. Many life insurance products do not make sense.

Pensions will not make their expected returns. There is no way they can make their expected discount rate. Banks are not going to be creating new loans in the current unprofitable environment because their margins are being further compressed. Banks were saved in 2008 with lowered rates. Now they are being destroyed. Short of charging all depositors, EU banks are being taxed with negative rates into oblivion.

Finally, the natural conclusion of negative rates will be to eliminate cash which receives a zero rate of return - much better than a negative yield. Some central bankers have started to call for an end of cash. If we have cash, it should only be in small denominations. There is place for savers and no place for financial service providers.

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