People are used to putting their money on deposit and earning a few percentage points per year on their savings. For many years Japanese interest rates have been negative – rather than the bank paying you to leave your money with them, they are charging you for the privilege of doing so. The Eurozone is similar with ECB rates hovering around -0.3%.
Only short term rates are negative, longer term rates have remained positive with fixed deposit rates for 2 to 5 years at about 1% pa. Negative interest rates apply only to funds the commercial banks keep on deposit at the ECB, although larger banks have said they will charge institutions and large businesses for their deposits.
Why would anyone want to pay a bank to hold their money?
Convenience and security is why. Business transactions using debit or credit cards, electronic funds transfers or even cheques are cheaper and easier to manage than cash. If a business decided to hoard cash and only accept cash transactions, they would need a large vault to hold it and lots of security to mind it, which costs a lot of money and paying a bank up to 30 basis points per year for payment services and security is worth it.
Do negative rates make sense?
The ECB says that negative interest rates are part of monetary policy. When the economy booms, the central bank raises interest rates to increase the price of money, reduce borrowings and cool the economy. When the economy is in a down turn, the central bank reduces interest rates to make money cheaper; encouraging banks to lend; business and consumers to borrow to invest or spend and reducing the value of the currency to make exports more competitive.
It doesn’t always work out and in foreign exchange markets – the euro and yen have both increased in value against the US Dollar; the negative interest rates only apply to banks excess reserves and there is no direct stimulus to business and consumers who are reluctant to borrow and who are not investing or spending.