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Who Suffers From Negative Interest Rates?
TND Guest Contributor: Paul-Martin Foss
Ever since the European Central Bank (ECB) decided to drop interest rates on its deposit facility into negative territory, there has been a lot of chatter about the consequences of those negative interest rates. A negative interest rate means that, when a depositor deposits money into an account, the depositor has to pay the bank for that deposit, rather than the bank paying the depositor as would be the case with positive interest rates. The ECB’s introduction of negative interest rates, first -0.10% and now -0.20%, was intended to keep banks from holding money at the ECB, and instead to lend that money to consumers and businesses in order to stimulate spending and economic recovery.
While the sums of money deposited at the ECB’s deposit facility have decreased significantly since the introduction of negative interest rates, it has not fallen to zero. Apparently some banks don’t mind paying interest to the ECB for the privilege of depositing their money there. But despite the fact that banks have to pay interest to the ECB, no one really thought it possible that negative interest rates could last in the long term. Eventually banks would pull their money out and either hold it or lend it, and in no way would these negative interest rates get passed on to consumers.
Now, Zerohedge reports that Bank of America may begin charging its European depositors. Just like the cost of extra taxes and regulations imposed by government never get paid by businesses and instead are always ultimately passed on to the consumer, so too are the costs of negative interest rates now being passed on to consumers who deposit their money in banks. The risk here, of course, is that depositors can always switch to a different bank or pull their money out of the bank altogether. And because banks’ lending business is dependent on depositors’ funds, the less money deposited the worse the financial situation of a bank.
Given the fact that banks today are fractional reserve banks, the deposit base makes up the small base of an inverted pyramid, with huge amounts of loans sitting on top of that base. At many banks if even three to five percent of depositors withdraw their funds, the bank would become completely insolvent. So if the ECB continues to drive interest rates even further into negative territory, and banks continue to pass those costs onto depositors, and depositors withdraw their funds, the entire banking system could come crashing down. A policy intended by the ECB to stimulate the economy would end up destroying it instead. One would certainly hope that the decision-makers at the ECB have thought through the consequences of their actions, but given how the EU has made a complete mess of fiscal and monetary policy over the past decade, we wouldn’t want to put too much faith in them.
Picture courtesy of Zerohedge.
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About Paul-Martin Foss:
Paul-Martin Foss is the founder, President, and Executive Director of the Carl Menger Center for the Study of Money and Banking, an Arlington, VA-based think tank dedicated to educating the American people on the importance of sound money and sound banking.
Prior to founding the Menger Center, Mr. Foss worked in the U.S. House of Representatives for seven years, including six years as Congressman Ron Paul’s legislative assistant for monetary policy and financial services, and one year as Deputy Legislative Director for Congressman Thomas Massie.
As Congressman Paul’s legislative assistant, he assisted the Congressman in his duties as Chairman of the Subcommittee on Domestic Monetary Policy by helping to develop hearing topics, agendas, and briefing Congressmen and their staffs on monetary policy topics. Mr. Foss also was responsible for the management of Dr. Paul’s monetary policy and financial services legislation, including the “Audit the Fed” and “End the Fed” bills, and was co-editor of Ron Paul’s Monetary Policy Anthology, a multi-thousand page compilation of hearing transcripts, lecture transcripts, and other documents related to Dr. Paul’s chairmanship.
Mr. Foss received his Bachelor’s degree from The University of the South (Sewanee), and Master’s degrees from the London School of Economics and Georgetown University’s Edmund A. Walsh School of Foreign Service.
This article appeared on the Carl Menger Center for the Study of Money and Banking and is reprinted with permission, “Creative Commons 4.0.”
Source: http://thenewsdoctors.com/who-suffers-from-negative-interest-rates/
