SwissBanking
The online magazine of the Swiss Bankers Association
March 30, 2015

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The serious consequences of the negative interest rates

The serious consequences of the negative interest rates

When the SNB lifted the minimum Swiss franc exchange rate in January, it kicked off 2015 with the economic event of the year. And once again, the banks will have to bear the consequences.

The decision announced by the SNB on 15 January 2015 to lift the minimum Swiss franc exchange rate was not detectable on any radar, nor could it be predicted by looking into a crystal ball, or reading tea leaves. From now on, weakening of the Swiss franc is to be achieved by means of negative interest rates for commercial banks instead of through foreign currency buying by the SNB.  

A multitude of problems

High costs for the banks

Banks are facing a multitude of problems following the increase in negative interest rates to -0.75 percent on SNB sight deposits and the further appreciation of the franc. The direct costs incurred by the negative interest rates, amounting to over a billion Swiss Francs, are only one part of the burden. A number of banks are not subject to negative interest rates due to the design of the exemption threshold. The burden placed on those banks that are affected is, hence, even greater.

Negative interest rates curtail profit

Even more far-reaching overall, however, are the repercussions on the interest margin business, which is one of the banks´ most important sources of revenue. Negative interest rates have resulted in a direct decline in interest margins, and therefore in a decrease in profitability. Competition between the banks and the option for clients to hold liquidity in cash do not allow for the negative interest rates to be passed on to individual clients.

Banks have to accept high interest rate risks.

Due to the significantly more negative interest rate environment, the costs for interest rate hedging in particular have risen. In some cases this has resulted in interest rate increases for mortgages and loans. As a result of cost savings on hedging transactions, banks have to accept high interest rate risks.

Widespread uncertainty

The new reality of negative interest rates on risk-free investments is also creating uncertainty in the markets, and this can take on a range of different characteristics. Risk-based pricing becomes more challenging. Insurance companies get a relative competitive advantage over the banks in the mortgage lending business, and the prevailing scarcity of investment opportunities for institutional investors is further exacerbated.

Strength of the franc is a burden on the economy

The impact of a strong franc on economic growth and therefore on the corporate clients business will likely be less dramatic than initially feared. This is also underlined in the monetary policy assessment recently issued by the SNB, which forecasts growth of just under 1 percent for the Swiss economy despite adverse conditions. There is a tendency, however, to forget that a large number of banks themselves also belong to the country’s traditional export industry. The whole export industry is negatively impacted by the strong franc because the Swiss franc ratio is significantly higher on the cost side than on the revenue side. The lower foreign currency valuations result in decreasing assets under management and as a consequence, to lower revenues.

The export industry is negatively impacted by the strong franc.

From sweet poison to a bitter pill

There is no use in complaining that the SNB did not take the appropriate action. To date, no one has come up with a convincing suggestion for a sustainable alternative approach. The interest rate decision also has positive effects on the banking sector, such as additional revenues in the trading business, an increased demand for hedging, or the stronger franc as a sign for foreign clients of the stability of the financial centre. But the SNB must now demonstrate just how the negative interest rate strategy can effectively have a dampening effect on the franc and that the approach it has chosen is efficient.

Further to this, the switch from sweet poison (unlimited central bank liquidity) to the bitter pill (negative interest rates), is also causing upheaval in the political arena. This usually goes hand in hand with a strong appetite for intervention, which could endanger those few advantages that currently exist for the financial sector.