An interesting banking phenomenon has begun to spread across the European Union. Incredibly, European Central Bank (ECB) is now charging depositors to store their funds in the bank.

As the ECB wants to grow the economy in the Euro area, it tries to encourage national banks to invest in the real economy rather than hold on to large amounts of cash reserves with the ECB. To do this, negative interest rates have been introduced.

Central bank rates going negative

With the economic crisis in Europe stubbornly persisting, the ECB has lowered some of their interest rates so far that they have dropped into negative territory.

In addition to stimulating the economy, negative rates are also used to control exchange rates. In Dec. 2014, the Swiss National Bank announced it would impose negative interest on large commercial deposits, in order to maintain a level exchange rate between the Swiss franc and the euro. This, in turn, would keep Swiss exports cheaper and therefore more competitive abroad, which should also help the Swiss economy.

By now, negative interest rates do not apply to corporate clients, as most of the negative rates reported in Europe are for “interbank” lending.

Unintended consequences of negative interest 

The biggest short term effect of negative interest rates, according to The Economist, has been to maintain stable currencies, such as those of Sweden and Denmark. However, other benefits of this unconventional monetary policy have yet to materialize.

And meanwhile, negative rates for interbank lending have begun to migrate to commercial accounts, such as pension funds. Rather than paying interest to keep his clients’ money in a Swiss bank, one fund manager recently attempted to withdraw a large amount of cash in order to store it in a vault. The bank refused to comply with the withdrawal, even though the money is a direct deposit that legally must be produced on demand.

In recent remarks Hervé Hannoun, Deputy General Manager of the Bank for International Settlements, notes that the long-term unintended effects of negative interest rates could include:

  • disincentive for governments to reduce debt;
  • distraction from making needed structural reforms;
  • disruptions to the financial stability of, for example, life insurance policies and pension funds;
  • And ultimately, a loss of confidence in the central banking system, because negative interest rates tax retirement savings and lead to lowered standards of living

It seems that the long-term consequences of negative interest rates have already arrived.

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