Andrew Dobbs, TCS Financial Solutions
There was a time when cash was considered to be more valuable than any type of financial asset. A business with a healthy cash flow on their balance sheet was viewed with envy by many organizations. Cash enables the smooth functioning of funding within financial markets and promotes economic growth. During periods of political instability or economic turmoil, investors have always traditionally turned to cash as a safe haven. Recently, however, banks, financial institutions and even depositors have started to be charged a fee on their cash reserves due to the introduction of negative interest rates from some Central Banks in the Eurozone.
In September 2014, The European Central Bank (ECB) announced that a negative rate will be applied to reserve holdings
in excess of the minimum reserve requirements. The Swiss National bank and Denmark’s Central bank have also recently followed suit.
These negative rates have subsequently spread to a range of Fixed Income Securities issued by countries within Europe, and who are now auctioning their bonds with negative yields. In effect, investors are now paying for the privilege
of lending money to governments.
We are all familiar with events leading up to the recent global financial crisis of 2007‐2008 and the resultant significant downward turn. Challenges in the Eurozone and the banking crises all converged to create uncertainty and gloom across the global economy. As a consequence, many Central banks cut their interest rates to help promote growth and head off deflation.
In addition to adopting negative rates, Central banks have also engaged in quantitative easing programmes (QE). This
involves the purchasing of assets to boost the flow of money within their respective economies. One consequence of QE is
that it can also peg interest rates. Central banks have also attempted to increase the supply of credit by reducing their funding costs and encouraging businesses and consumers to borrow money at reduced rates thus stimulating their respective economies.
Central bank rates represent the rate of interest that a Central Bank is prepared to pay on the reserves that commercial
banks hold with them. These reserves can be converted into cash at the level of short‐term rates in the wholesale money
markets. The Central Bank rate can also determine retail lending and deposit rates charged to retail customers and businesses.
- So why are Central Banks setting their rates below zero?
- What does it mean for commercial banks and companies and their cash reserves?
- What is the impact on investment banks (buy side and sell side), especially with respect to their financing activities?
- How does this impact custody banks and collateral management providers?
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