Even as recently as March of this year, current Bank of England (BoE) governor Andrew Bailey didn’t see negative interest rates as a “plausible tool” for the UK. But it seems a lot has changed since then. We’re not quite there yet, but the BoE seems to be certainly warming to the solution. It’s an increasing possibility that we’ll see negative interest rates in the UK. Banks, investors, businesses and other stakeholders should be prepared.
It’s worth noting that negative interest rates are nothing new. They’ve been used with varying degrees of success across Europe and in Japan: Denmark first used negative rates around six years ago, with the European Central Bank (ECB) following suit in June 2014. They are also rational, reflecting a situation where the cost to store money outweighs the expectation of opportunity cost, credit risk and inflation.
While there’s mixed support for negative rates in the UK, we may have little choice but to adapt to global trends. Despite economists and executives warning of illogical incentives, adverse outcomes and unintended consequences, it seems that the BoE is running out of alternatives to prop up the economy. Ultimately, it may need to follow the ECB’s lead.
A move below zero may be an unwelcome experiment for markets. But for banks and boards, negative interest rates are now a possibility that they should prepare for.
Be ready for whatever happens
To be ready, banks will need to prepare in three ways:
- Technical – is every major area and system ready for every possible risk?
- Financial – are they ready for the business and financial impact?
- Strategic – have they thought about the fundamental choices they’ll need to make?
Take practical steps now
Whether rates enter the negative territory or not, we’re looking at an era of lower-for-longer. We’re barely above zero as it stands, so, whatever happens, banks need to think about the ‘no regrets’ steps they should take.
- Ensure readiness – Think about using a signal, stock and flow framework across each element of the extended balance sheet to work out risks and opportunities.
- Get fit to compete – Prepare the franchise, operating model and balance sheet for resilience in the face of challenges to come.
- Position to thrive – Be bold: make decisions so that the bank can thrive in this new environment.
Opportunities for the prepared
While preparations such as scrutinising cost, fee income, credit, balance sheet and capabilities are nothing new or groundbreaking, they are sensible. In fact, the priorities shouldn’t be any different to what they already are, but this looming situation does raise the stakes and the urgency.
As rates and margins continue to drop, so will returns from maturity, credit and liquidity transformation. Regardless of why or how low they go, banks are going to have to respond.
Negative rates are no longer impossible. They’re not even improbable. And they’re going to have a significant impact on unprepared banks and institutions. However, those who are ready will find the next era as full of opportunity as those we’ve recently experienced.
Read our latest in-depth report looking at how to prepare for negative interest rates. You might also be interested in the other articles in our Where next? series, which consider how COVID-19 is affecting industries and how organisations can transform to meet the challenge.
By Julian Wakeham, EMEA financial services consulting leader at PwC