Spectre of negative rates sends a chill through Britain's banks

Dipping rates below zero, following Japan and Switzerland, means banks would be charged for hoarding cash rather than lending it out

In 1984 Birmingham-based Midland Bank, then one of the UK’s big four banking groups, made a radical decision that fundamentally changed Britain’s banking sector. Concerned about losing customers, it decided to ditch fees for cheques, statements and standing orders. Within a year it signed up to 450,000 new customers and its competitors soon followed suit. But five years ago Hervé de Carmoy, who became chief executive of the bank shortly after it abolished the charges, told this newspaper it was a mistake

“In retrospect, you could say it was imperfect reasoning. I don’t think we should have given up a major source of income [like that],” he said. 

Now banking sources say the idea of bringing fees back for those holding money - most likely for large clients - is not impossible after the Bank of England on Monday told lenders it was seriously considering turning rates negative for the first time in its history. Dipping rates below zero, which has already happened in Japan and Switzerland, means banks would be charged for hoarding cash rather than lending it out. The lower the rate, the less profit they make. 

"Bank profits have collapsed because the money can't be put to use with a good interest margin [the difference between their cost of borrowing and the rate at which they can lend money] in today's conditions," says Sir Philip Hampton, the former chairman of the Royal Bank of Scotland. "It's the opacity on how much banking costs and how it should be paid for which is now being questioned by the interest rate environment."

John Cronin, a banks analyst at Goodbody, agrees that the imposition of negative base rates would inflict further damage on revenues and so banks will most likely "look at charging business and retail customers with large balances to offset some of these headwinds".

Banks are bracing themselves for rates to go negative less than a month after economists at the Federal Reserve Bank of San Francisco sounded a warning about such a move. It said that "both bank profitability and bank lending activity erode more the longer such negative policy rates continue" and that "bank lending - which is often the motivation for negative policy rates - increases only during the first year under negative rates". "Lending declines over the next two years, more than reversing any initial gains," it added.

But there are more pressing issues for lenders to deal with first, notably the fact their systems need to be updated for a cut. PwC warned its banking clients in July that they had "no choice" but to "batten down the hatches" and prepare for negative rates by updating their IT systems.

"There is a ‘Y2K’ aspect to being ready for negative rates, as an enormous number of models, reporting systems, contracts and processes were designed by people who believed interest rates could only ever be positive," the report read, referring to The Millennium Bug, or Y2K, which saw huge numbers of developers working to update systems to ensure they could cope with dates beyond 1999.  

Banking insiders insist that the preparations are not a "big drama" although they will no doubt be spending huge amounts of time and money getting ready for the shift. The industry has been pushing for a timeline from the Bank of England under talks being led by bank lobby group UK Finance, The Mail on Sunday reported at the weekend.  

Bob Wigley, the executive chair of UK Finance, said that deciding whether to pursue such a measure, the Bank of England "would no doubt have due regard to the implications for banks’ business models and their ability to serve customers, which are already impacted by Covid-19".