UK banks have hit out at the prospect of negative interest rates, saying the policy would slash their earnings and limit their ability to absorb an expected torrent of coronavirus-related loan losses.
With big British lenders on track to boost reserves to £18.5bn for bad debts in 2020, the Bank of England’s admission this week that it was eyeing negative rates for the first time in its 324-year history has caused deep concern in the sector.
BoE governor Andrew Bailey on Wednesday said a further cut in the central bank’s current 0.1 per cent rate was under “active review”. It is keen to spur companies’ spending following a collapse in economic activity during the Covid-19 lockdown. Negative rates are in place in Scandinavia, Switzerland and the eurozone.
Such a move in the UK would narrow lenders’ net interest margin — the difference between what they charge borrowers and pay out on deposits — and depress already fragile profitability in an industry that has struggled to recover from the financial crisis.
Stephen Jones, head of UK Finance, an industry lobby group, said the jury was “still out” on whether negative rates stimulated spending, based on the experience of other countries.
“Negative rates would further suppress bank profitability at the very time their balance sheets are supposed to act as a shock absorber for tens or even hundreds of billions in potential credit losses,” he added.
Bank of America analyst Rohith Chandra-Rajan estimated a BoE rate cut to minus 0.25 per cent would depress the banking sector’s average return on equity into low-to-mid single digits and take 50 per cent off Barclays’ domestic pre-tax profit. This hit would rise to more than 70 per cent for lenders such as RBS and Virgin Money.
“If you were thinking it couldn't get worse . . . negative rates would have a much longer-lasting impact on UK banks’ profitability than current concerns on credit quality,” said Mr Chandra-Rajan.
One banking executive said negative rates would have a “devastating impact on profits”.
“The double-whammy of loan losses and then not making money in the core business of taking deposits and lending, it’s potentially problematic to say the least,” he added.
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If the BoE were to proceed with negative rates, bankers said potential offsets would include charging corporate and institutional clients to deposit money, plus richer customers with more than the government-insured £85,000 in their accounts. However, these steps would take time to implement and be contentious.
“The main impact will be determined by how broadly we can pass on the impact to customers,” said a UK banking executive. “In Germany that has tended only to be OK for large, mega-corporate depositors. For ordinary retail customers and savers, it is simply politically impossible.”
Investors are also unhappy about the possibility of negative rates, after British banks last month bowed to pressure from the BoE’s Prudential Regulation Authority and halted dividend payments.
That has helped drive down shares in FTSE-listed banks by 37 per cent so far this year, to levels last seen around the 2008-09 crisis.
“I had been very impressed by the way the BoE and the Treasury have co-ordinated policy thus far,” said Richard Buxton, head of UK equities at Merian Global Investors, noting how banks had participated in the government’s virus-related schemes to provide loans to companies and mortgage payment holidays to households.
“For the BoE to now move to negative rates, which hurts banks — whilst the Treasury is trying to help them help the economy through loan guarantees, mortgage payment holidays et cetera — would seem utterly counterproductive if not barmy.”
Alex Wright, a fund manager at Fidelity International, said that while bank stocks were “extremely cheap” and the sector “extremely well capitalised”, he had cut his exposure to them from about 10 per cent 18 months ago to 4 per cent now.
Negative rates on top of banks’ other problems “is bad . . . the more retail focused, the bigger the hits. It would be most negative for Lloyds in the UK,” he added.
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