The negative interest rates imposed by the Bank of Japan have begun to make their way into the Japanese banking system. Japanese trust banks have begun to impose negative interest rates on accounts held by institutional investors. It shouldn’t be surprising that Japanese banks are trying to pass on the costs imposed by the central bank’s policy of negative interest rates. It happened in Switzerland, it is happening in Japan, and it will happen in Europe. And as it becomes more widespread, investors will begun to withdraw their funds from the banking system.
Some people, such as Ben Bernanke, don’t think that will have much of an effect on the banking system.
It seems implausible, though, that modestly negative short-term rates would have large incremental effects on bank profitability or lending. Contrary to the simple story, most U.S. bank funding does not come from small depositors, but from wholesale funding markets, large institutional depositors, and foreign depositors, all of whom would presumably accept a marginally negative rate if the alternative were holding currency.
It’s actually the depositors at either end of the Bell curve who would be most likely to withdraw their funds. The depositor with $500 in the bank who is facing guaranteed losses might just pull out five $100 bills and stuff them under his mattress. Similarly, a large institutional depositor with $500 million or more in funds facing a negative interest rate of -0.10% (a cost of $500,000+ per year) might find it more worthwhile to build a safe room and hire armed guards, particularly if he thinks negative interest rates will be around for a long time. It is the depositors with in-between sums, too much to stuff under the mattress but too little to assume full responsibility for guarding their money, who will be affected the most.
Regardless, in a fractional-reserve banking system in which banks may have only 10 percent or less of their deposited funds on hand to cover withdrawals, checks written on accounts, etc., even a small fraction of deposits being withdrawn can have severe ramifications. If three percent of a bank’s deposits are withdrawn overnight, the result could be an inability to clear checks or pay other liabilities. If the bank is unable to raise liquidity over a period of several days, confidence in the bank would be severely eroded, possibly forcing it to go under. And once one bank goes under, how long does it take for this lack of confidence to pervade the rest of the banking system? An erosion of confidence can be contagious and lead to major bank runs. And all of it might happen in an instant.
Knowing that negative interest rates that are too low could lead to those results and yet continuing to push rates ever more negative is completely irresponsible on the part of central banks. It is like stepping towards the edge of a cliff, knowing that at any moment your foot might slip and send you careening over the edge, and yet continuing to walk towards it. No sane person would do that. But then again, these are central bankers we’re talking about. These are people who create bubbles and recessions by pumping newly-created money into the system, then attempt to “cure” the recession they caused by pumping in more money and creating more bubbles. The disastrous effects of easy monetary policy and the push for negative interest rates should make it obvious that central bankers have no idea what they are doing and will only create more harm and misery.
