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Low Rate Pushback - September 10, 2019

The ECB’s Governing Council is set to meet in Frankfurt this week, followed by the BoJ and FOMC meetings next week. Market participants are anxiously waiting to see not if, but by how much each central bank will cut. However, there is a growing chorus of bankers (not to mention Larry Summers) who are warning of the dangers of low and negative rates.

 “Don’t Consider This A Sustainable, Responsible Policy”

When banks announced earnings back in August, Elliot Smith at CNBC wrote about prominent European banks being concerned their profits were being affected by “the world’s low rate environment”. The banks cited “current central bank strategy as a key risk to future profitability”. The head of Credit Suisse said, “I am not a great fan of low-interest rates” and warned, “subsidies to debtors and penalties for savers, I think in the long term harms the economy”. Deutsche Bank’s earnings report stated that “If conditions were to persist... this could result in a significant impact on revenues relative to our current expectations”. The CEO of UBS added to the outcry, saying “I’m not sure going deeper into negative territory or using the QE is the way to get out of the problems” and asserting “there are severe broader considerations than just the banking industry”.

Warnings from European bankers continued last week. According to a Reuters article, the CEO’s of Commerzbank and Deutsche Bank “warned that a further cut in interest rates by the European Central Bank would deal a blow to savers and the financial system while having only minimal effect on the economy”, and “the majority of the population would not benefit”.

 “But For Us, There Would Be No Merits At All”

Japanese bankers have pushed back against negative rates too. In August, Ichiro Fujiwara, head of an association of Japanese banks, warned: “deepening negative rates would add to the cumulative pain on the banking sector from years of ultra-loose policy”. Even some of the members of the BoJ are concerned about “potential dangers if the central bank’s already massive stimulus is ramped up”. Another article from Reuters states, BoJ Policy Board member Hitoshi Suzuki believes “further declines in rates could do more harm than good to the economy as it would prompt financial institutions to charge a fee on deposits”. Suzuki is broadly concerned that interest rates are approaching “the level at which the demerits of low-interest rates exceed the benefits” at the same time “years of ultra-low rates strain financial institutions”.

 “It Doesn’t Need To Be That Way”

Though bankers may seem like petulant toddlers, crying over a drop in their profitability, in an ongoing article series (1,2), John Hempton explains why banks may be right. He says “there are limits on how far interest rates can be cut” before bank margins are too low. However, Hempton argues that central bank policy is a weak driver of margins, whereas the competitive landscape is “a strong” driver of margins. He then points out that Irish, Scandinavian and some French banks are okay, “even in a negative interest rate world”. Though he says, “nailing down quite why” these banks “are outliers is hard”, he believes that central banks “need to learn from the banks that have maintained reasonable profitability in the face of negative rates”.

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