How banks can ease the pain of negative interest rates

McKinsey 03 Mar 2020 12:00

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By significantly reducing interest rates, central banks in Europe, Japan, and the United States have sought to stimulate economic activity, stabilize banking systems suffering from nonperforming loans, and manage exchange rates. A few have even pushed reference rates toward zero and below, while also undertaking quantitative easing in the form of bond-buying programs, to push down term rates as well. Against this background, central banks are contemplating broader and more intensive implementation of negative rates in case of a severe downturn.

While economies have benefited, low and negative interest rates come with strong side effects for investors and financial institutions. Over time, negative interest rates hurt profitability by eroding banks’ net-interest margins. Japanese banks, for example, first saw net-interest margins increase as client rates on deposits were reduced faster than average rates on loans. 1 1. Christian Weistroffer, “Ultra-low interest rates: How Japanese banks have coped,” DB Research, Deutsche Bank, June 10, 2013, Soon thereafter, however, net-interest margins steadily declined as yields on loans and bonds acquired declined, pushed down by the Bank of Japan’s quantitative-easing program. The increase in balance-sheet volumes did not offset the decline in net-interest margins.

The impact on banks of negative-interest-rate policies varies according to the bank’s business model. Smaller banks focused on domestic loans and deposits are often hurt more than larger banks, which tend to be more diversified across currencies and have a larger share of fee business. Banks of all sizes should prepare for the long-term effects of negative interest rates and quantitative easing by adopting a comprehensive program of countermeasures. Treasurers will be instrumental in designing and implementing these measures.

Negative interest rates and quantitative easing create specific challenges for each component:

Even if interest rates remain stable over the next five years, the impact of negative rates will continue to squeeze net-interest margins, especially the structural elements. Consequently, the net-interest margin for banks in the eurozone could decline by another 8 basis points during this period. If the interest-rate curve were to move down another 50 basis points, the net-interest margin would drop by a further 8 basis points—or more—depending on the reaction of banks and clients (Exhibit 3). 8 8. For similar results, see “Results of the 2019 LSI stress test,” BaFin, September 23, 2019,; see also “Sensitivity Analysis of IRRBB – stress test 2017,” European Central Bank, February 28, 2017,

The treasurer’s role in building resilience

Optimizing the risk–return profile of the structural components of net-interest margins

Stabilizing client-related components

These actions may include a temporary increase in the loan-to-deposit ratio, reversing the traditional paradigm of targeting a low loan-to-deposit ratio. Denmark, Japan, Sweden, and Switzerland all took this approach from 2014 to 2018 (Exhibit 4).

Our experience and analysis suggest that treasurers may be able to mitigate most or all of the forecast depletion of net-interest margins for the next five years, through a combination of these mitigating measures (Exhibit 5). 9 9. “2020: Europe rising—at the break of dawn,” Morgan Stanley, December 2019. The degree of mitigation will depend on a bank’s business model, its risk appetite, its ability to employ more capital, and the degree to which the specific levers discussed above have already been deployed. The exact shape of the yield curve will also play a role.

Steering the business

Treasurers can thus increase the efficiency of their own oversight and bring valuable counsel to the executive suite. Depending on the business model, the regional setup of the bank, and the deployment of additional capital, a comprehensive program can improve net-interest margins by up to 10 basis points. But timely and decisive action is of essential importance.

While today’s interest-rate environment poses enormous challenges to growth in the banking sector, many of the tools for addressing the challenges are well known to treasurers. By taking a more holistic approach to using these tools, bringing their own considerable expertise to bear, and establishing a joint-management view on strategic planning and balance sheet–capital management, treasurers can play a vital role in their banks’ financial success in the next period.

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