High street banks have reportedly been busy preparing for negative interest rates. But what are negative interest rates – and what would they mean for your small business?
The deputy governor of the Bank of England, Sam Woods, has written to banks to find out whether they’re operationally ready for negative interest rates.
While the Bank of England has said that this doesn’t mean the policy will be adopted, it’s important to understand how it could affect your money.
Let’s look at the base interest rate first.
Interest refers to the cost of borrowing money. If you lend a friend £50 and you get £55 back in a year’s time, you’ve charged them 10 per cent annual interest.
With this in mind, central banks (like the Bank of England) set a base interest rate that dictates how much they’ll charge commercial banks to borrow money from them.
This means that the base interest rate has a big impact on the interest rates that commercial banks then charge consumers for borrowing money.
It also has a big impact on the interest that commercial banks pay consumers for saving money (you’re essentially lending a bank your money when you save money in a savings account).
Base interest rates are influenced by the wider economy. Base interest rates have broadly been low since the 2008 financial crash, in a bid to get consumers to spend money rather than save.
Compare the base rate in December 2007 – 5.5 per cent – to the base rate ten years later in November 2017 – 0.5 per cent. The highest the base rate has been since 2009 is 0.75 per cent (in August 2018).
And following the outbreak of coronavirus at the beginning of 2020, the Bank of England dropped the base rate from 0.25 per cent to a record low 0.1 per cent.
Throughout the coronavirus outbreak, the Bank of England has consistently said it’s not ruling out a negative base interest rate.
This would see the base rate fall to something like -0.1 per cent. Commercial banks could then be paid to borrow money from the Bank of England, or charged to store money with the central bank.
Negative interest rates have been used in countries like Japan, Sweden and Denmark. It’s an extension of the theory above – interest rates of 0 per cent and lower should encourage borrowing and spending, rather than saving.
But in practice, negative interest rates create challenges for commercial banks and consumers.
For example, would commercial banks pay consumers to borrow money, or charge them to save money?
And if you’re a small business looking for funding and finance, how cheap (or even profitable) could it actually be to borrow money?
The Yorkshire Post reports that during a roundtable discussion with local business owners, Silvana Tenreyro, a member of the Bank of England Monetary Policy Committee, said: “Lower rates mean lower borrowing costs and that's a positive for businesses.”
But you shouldn’t expect to be paid to borrow money. Martin Lewis, from MoneySavingExpert and speaking on BBC Radio 5 Live, says that people with mortgages and other debts aren’t likely to be paid a negative interest rate.
If you’ve got an existing business loan, you’ve already agreed to a fixed amount of interest. And even if it’s variable, which moves in line with the base rate, the terms and conditions of the loan probably state that the interest rate can’t fall below a certain figure.
If you’re looking to take out a loan, you might see attractive products that have low interest rates, but nothing below 0 per cent.
That’s because high street banks will need to remain profitable. And if negative interest rates come with operational and commercial challenges, banks might become more reluctant to lend – not the outcome the Bank of England wants to see.
Martin Lewis says this is more plausible than being paid to borrow money, pointing to UK euro bank accounts: “It costs you money to put money into those savings accounts and I think that is a plausible option, certainly for those with larger savings. If we go into negative interest rate territory, you will get no interest and you need to start paying a fee.”
Again, though, there’s the question about the operational and commercial interests of high street banks. If a bank starts charging savers a fee, they might switch to another account. And as Lewis suggests: “Ultimately you'd say 'why don't I start keeping the money under the mattress?'”
The interest rate on many savings accounts is already pitiful, so banks would unlikely want to penalise everyday savers much further.
As mentioned, while the Bank of England clearly hasn’t ruled out implementing a negative base rate, it doesn’t mean they’ll eventually adopt the policy.
Professor David Miles, an academic at Imperial College and former member of the Bank of England’s Monetary Policy Committee, told the university’s newsroom: “The message that’s coming back very strongly from financial institutions and banks, is ‘this is messy, difficult and will make life hard for us’.
“I think there’s mixed-evidence inside the Bank of England about how effective negative rates would be, so on balance you probably couldn’t get a majority on the Committee to vote for it, at least not now.”
So for now, with small businesses potentially needing better access to finance over the coming months (and years), it’s an interesting theory to keep an eye on.
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