Negative Rates Can't Halt Record Bank Profits, Is Lesson for Now

For banks operating in the country to have endured negative interest rates longer than any other place on earth, last year was actually pretty good.

The place in question is Denmark, where rates have been mostly negative since mid-2012. The governor of the central bank, Lars Rohde, says markets may well be right to assume they won’t go positive until 2019. So how does a financial industry cope with a negative interest rate policy for the better part of a decade?

QuickTake Negative Interest Rates

While the Danish Financial Supervisory Authority has yet to release aggregate figures, Rohde says it’s already clear that in 2015, his country’s banking system “had its most profitable year since 2008.” Danske Bank A/S, Denmark’s biggest lender, delivered its best annual result on record. This year, its shares have outperformed most major European peers, helping it surpass Deutsche Bank AG in market value.

And though there are concerns -- most recently articulated by UBS Group AG Chief Executive Officer Sergio Ermotti -- that banks will develop laxer credit standards because of negative rates, the Danish experience suggests that’s not an immediate issue. Jesper Berg, director general at the Danish FSA, says “we’re not seeing it yet.”

Here’s what’s helping:

  • Though lending income has suffered, lower rates mean borrowers are less likely to get into trouble with their loans. Danske has written back once impaired loans every quarter since March last year.
  • Banks are earning fees as customers move savings out of deposit accounts and into asset management services. Danske last year combined functions to create a $130 billion wealth management unit.
  • The central bank has a tiered deposit system, meaning the negative rate only affects funds that can’t be accommodated in a current account facility that pays zero. Rohde says the policy was deliberate: “we were not doing this to harm the profitability of the banking sector. Therefore we implemented it in a way that it was only on the margin that you had a negative rate.”

But the jury is still out on the long-term effect of negative rates. Berg at the FSA says there are a few caveats to keep in mind. For example, banks still generate interest income from old (higher paying) contracts and will only feel the full effect of negative rates once these fully expire.

“Clearly, we haven’t seen the full impact of the negative rates also on the net interest income,” Berg said in an interview in his office in Copenhagen. “If you compare the interest rate statistics on existing loans and new loans, you can see that new loans are at lower interest rates than existing loans, which implies that the stock has not yet been churned over to reflect the present market rates. That impact will come with a lag.”

And though risky lending isn’t such an issue just now, “there is concern that it could” become one, Berg said.

The Bank for International Settlements says negative interest-rate policies currently in use by central banks around the world have worked through their respective systems in much the same way as positive rates. But, in a report published on Sunday, BIS also said it’s not clear how far below zero that would continue to be the case.

“There is great uncertainty about the behavior of individuals and institutions if rates were to decline further into negative territory or remain negative for a prolonged period,” BIS said. “It is unknown whether the transmission mechanisms will continue to operate as in the past and not be subject to ‘tipping points’.”

Berg notes that Denmark is a special case because of its unique so-called pass-through mortgage finance system.

“One thing that’s very, very important in Denmark is that two-thirds of all credit comes from the mortgage credit institutions, which fund themselves at market rates below zero,” Berg said. “That is a model which is pretty robust in relation to rates going negative in terms of maintaining margins.”

Rohde, who according to Danske Bank will probably cut Denmark’s deposit rate by 10 basis points on Thursday to track the ECB, says a key worry is how negative rates affect the housing market. It’s also worth noting that Danish households owe their creditors about three times their disposable incomes, which the OECD says is a rich-world record.

“Over the long term you would have to expect an influence on the housing market and on other assets,” Rohde said. “It raises concerns for financial stability.”

But with all the caveats, the upshot is that “Europe can learn” from Denmark’s experience, Berg at the FSA says. And the lesson learned is that “you can go below zero without destroying the banking system.”

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