Negative interest rates: necessary from a monetary policy point of view - but with what risks for the banks?

Fritz Zurbrügg, Vice Chairman of the Governing Board

Volkswirtschaftliche Gesellschaft des Kantons Bern, Berne, 24.11.2016

The negative interest rate charged on banks' sight deposits at the SNB since January 2015 is necessary from a monetary policy perspective. Given low interest rates around the world and the difficult global economic situation, negative interest - coupled with the SNB's willingness to intervene in the foreign exchange market - serves to ease upward pressure on the Swiss franc. Negative interest helps to stabilise prices and support economic activity in Switzerland. These are also important preconditions for a profitable, stable financial system.

At the same time, the current interest rate environment is fraught with challenges. Above all, a prolonged period of low interest rates can have economically undesirable consequences for financial stability. Low interest rates weigh especially on banks' profitability in interest business, and can thereby encourage excessive risk-taking.

In Switzerland, this is particularly true of the domestically focused banks, whose operations are heavily geared towards interest business and whose interest rate margins have indeed come under pressure in the wake of the exceptionally low interest rates since 2008. However, the negative interest rate per se has not thus far caused an additional erosion of their profitability. This is partially due to the fact that, thanks to the exemption thresholds granted by the SNB, negative interest has not yet resulted in any material direct costs for most domestically focused banks. At the same time, the banks have responded to the negative interest rate by further raising asset margins and their risk appetite in lending activities.

The consequences of persistently low interest rates for financial stability can currently be deemed as manageable. The significant capital surpluses held by the domestically focused banks and the coordinated measures taken in recent years by officials, the SNB and the banks have all played a role in this regard.

However, the longer the banks are exposed to exceptionally low interest rates and associated profitability pressure, the higher the incentive to take on more risk. This applies first and foremost to the assessment of affordability in relation to mortgage lending and the size of unhedged interest rate risk from maturity transformation. Consequently, the already significant imbalances on the Swiss real estate and mortgage markets could increase again over time.

In the spirit of a cautious, forward-looking approach, it is thus essential that banks apply conservative principles in their lending activities. It is important when assessing affordability and the relevant interest rate to remember that real estate is normally purchased over a long time horizon of several decades. In time, interest rates may well be considerably higher than they are today. While a sharp interest rate rise is unlikely in the short term, borrowers and banks should not assume that today's favourable financial conditions will endure for their entire planning horizon.