While the idea of negative interest rates that emerged after the 2008 financial crisis in order to stimulate lending, spur inflation, and reinvigorate economic growth has become entrenched in parts of Europe, it has also led to property bubbles and wealth disparities.
Denmark, which has had subzero rates longer than most other European countries, is on its way to becoming a blueprint for the negative-rate economy, as the real cost of the regulation designed as a short-term fix to stave off crises will make itself felt, according to Kristian Vie Madsen, deputy director general at the Danish Financial Supervisory Authority (FSA).
“Now is the time that you, to a larger extent, will be able to see the problem in the profits of the banks”, Madsen told Bloomberg, suggesting that “the worst is yet to come”.
According to the Danish Bankers’ Association, negative rates pose a serious threat and are estimated to have cost the industry around DKK 2.5 billion ($371 million) last year alone. By contrast, with positive rates, banks could have made around DKK 3 billion ($440 million).
In Denmark, banks have so far relied on “a lot of one-offs” to offset losses, as Madsen put it, such as historically low loan impairments, high bond-portfolio valuations and record rates of mortgage refinancing. However, those effects are coming to an end, he warned.
“There are not that many one-offs that can save the results for the next year”, Madsen stressed.
Not only do negative rates add to banks’ cost of holding bonds in order to meet liquidity requirements, but also force banks to impose fees on retail clients with large deposits, in an bid to get rid of surpluses. This can’t but negatively affect deposits.
As the Danish experience reveals, negative rates also cause an increase in property prices, as investors prefer tangible assets in times of uncertainty (which negative rates tend to imply), creating propery bubbles. In 2019, Danish house prices reached their highest-ever levels, growing by 4.2 percent in a single year. Additionally, widening inequality in the nation has also been linked to the negative interest rate environment, which is not likely to change in the coming years.
According to Madsen, FSA is now on the lookout for banks that try to cope with the tougher climate by overselling their loans. He urged the industry to be more disciplined in dealing with costs.
Low-interest rate environments have been developing at an unprecedented pace since the 2008 financial crisis in an attempt to stimulate investment, employment, and inflation levels. The rationale is that low-interest rates encourage more spending and investment, contrasted by the slim returns offered by cash savings accounts.
Denmark became the world’s first nation to introduce a negative base rate in 2012, partly to maintain its currency peg to the euro, as it emerged as a safe-haven economy following the recession. Markedly absent from the Eurozone, Denmark was seen as a credit-worthy sovereign nation by investors. Since then, a negative-rate policy has been mimicked by Switzerland, Sweden, Japan, and the EU.