One of the biggest topics in finance this year has been negative interest rates.
Assigned by federal or central banks to avoid a deflationary spiral, negative interest rates can be a pretty favorable deal for consumers to free up cash flow and borrowing. However, they’re also untested in the US.
In the economic recovery for COVID-19, negative interest rates have been reexamined as a means to boost borrowing and economic activity. While we haven’t pulled the trigger quite yet, the discussion is getting louder. To see what they’d look like stateside, we’ve decided to put together a guide on what you should know about them, as well as if they could possibly be a positive move for you or your business. Here’s what we’ve gathered:
What’s a negative interest rate? Why would a bank accept that?
Considered one of the more desperate moves from central banks when trying to avoid deflation, negative interest rates are primary tools for encouraging lending and spending rather than saving cash. Early cases in Europe of negative interest rates charged for storage fees rather than accruing interests, meaning it costs money to keep your cash in the bank.
Although often a last resort, with COVID-19, the Federal Reserve has been flirting with the idea of negative interest rates. As noted by CNBC, this could open up more borrowing, however, it doesn’t mean that ‘people will pay you to take out a loan’. Instead, it’s simply to encourage borrowing and circulation, which can be risky for consumers and business owners that are bad at managing credit, tie their money into assets that appreciate, or want to have a reserve of cash.
What are the pros and cons of negative interest rates?
Negative interest rates can help open up spending, which comes with consequences without the proper guidelines in place.
The fear of people defaulting is always a risk, however, a bigger concern is putting borrowers in a credit-trap. Essentially, this would be when someone is being charged such a high storage fee for their cash against the loan that they’d practically always be breaking even (similar to how high-interest rates were with predatory lending). Furthermore, even those who are financially sound might end up in a worse-off financial situation, incurring debt they otherwise didn’t need to borrow. Although the latter is common even in positive lending periods, the idea of a negative interest rate could sound too enticing for some to pass up, which is dangerous when you don’t know the in’s and out’s.
On the flip side, borrowers who are smart about how they manage negative interest rates could bring about a new instrument for leveraging their debt. Since extra capital could help quite a bit with new projects, the basic equation is what type of ROI someone will receive against their storage fee. Like any other loan, someone needs to be making money on the other end, which means it’ll ultimately come down to how much spending power a borrower has versus how much they’ll make off that capital in the long-term.