Every day the news of high interest rates causing the problems to the common man is highlighted in the news. Amidst this came the story of Negative Interest Rates. Have you ever imagined what Negative Interest Rates would look like? The following piece sheds light on the given issue.
As Popular Economic Theory and Empirical Evidence suggests demand and supply are the two most important factors required for the fixation of prices. The theory is not just valid on the product market but is universally applicable, finding a way into the interest rate market where it lends a helping hand to fix the interest rates provided by the market for various requirements of people. Despite this, loans are given for different reasons and at different rates of interest in different places across the globe. This is largely due to the different supply and demand conditions in their economy respectively. One latest change in this interest rate market that has taken the world by surprise is the policy of negative interest rates. Brought to controversy by Jyske Bank (the third largest bank in Denmark) on 5th august, 2019, the bank offers an interest rate of a minus 0.5% on housing loan for a period of 10 years. Surprisingly, this is not the only bank with such a policy. Another Finish bank called Nordea Bank is giving loan facility for twenty years at 0% interest and also offering a loan for thirty years at only 0.5% interest rate. This shows the current situation in Denmark and many other countries as abysmal where there are institutions ready to lend their money for as long as thirty years at only 0.5% rate of interest. This also goes on to show about the high supply of credit with very less demand.
Though there is still a lot of confusion relating to what negative interest rates means and why would banks take on such losses. These questions will be discussed ahead. When we say that the rate of interest is negative, I wish to break the popular misconception that it does not mean that bank would be paying the borrower. It just means that every time an installment is paid to the bank, the amount deducted from the outstanding amount of loan is more that the installment paid by the borrower (i.e. an installment of 25,000 would be regarded as equivalent to an amount more than that perhaps something close to 26,000). This can be understood by the following example. If a loan of 2,50,000 Danish kroner is to be repaid in 10 years as 40 quarterly installments then the total repayment including all bank charges sums up to be 2,77,392 Danish kroner despite the rate of interest being negative. This shows that even after there being a negative interest rate a borrower has to pay around 11% interest rate. So before taking the loan one must also consider all the bank charges that have to be paid. The banks generally demand a fee which is high enough, thus compensating for the low interest rate. Another aspect of this scheme is that the tenure of the loan is just 10 years so, it cannot be used to purchase a house but can only be used while making some major renovations. If a longer term loan is required then the policy of negative interest rates isn’t available. In 2015 as well, these banks began lending money on negative interest rates but these loans were for a very short duration. Whereas the new policies are for a loan as long as 10 years thus, raising the bar much higher and creating a global news.
The aim of giving loans at low interest rate can be both, because of the lack of demand of funds and the policies of the central authorities when there is a high rate of depression. This is because the money is not just used once but keeps on changing hands thus contributing towards the improvement of economy multiple times (creating a multiplier effect). The banks when lowering their interest rate only reduce their profits as they still earn through the various charges like processing fee among many other.
There also came another scheme by the same Danish bank, Jyske bank which was offering negative interest rate that it will now charge an interest rate of minus 0.6% on all deposits made above 7.5 million Danish kroner. This means that the rich will now also lose money every year by depositing money in the bank. This is also opposite to the normal circumstances where there is a positive return on the credit balance of your savings account. This can also be looked as Denmark’s approach towards working on the Gini Coefficient by reducing the gap between the rich and the poor. Though the success of this plan is still not guaranteed but the scheme is definitely intended to do that and is definitely one of a kind.
Denmark isn’t the first country to make such a financial change. There are many instances all over history showing how interest rates were set low and even in the present scenario, many countries like Switzerland have low interest but didn’t gain much public attraction as much as Danish banks. This is perhaps due to the fact that even though they had a very low interest rate but they were still positive numbers and Denmark is the first to introduce negative interest rates which to a common man isn’t easily understandable. Also there are some reports which tell that USB, the Swiss banking giant is considering implementing an interest rate of minus 0.75% to clients with deposits over two million Swiss francs. Thus, in the upcoming time, there are many more such cases expected and is seems that finally the interest rates are going to come back down after soaring up high in the sky for so long.