Negative interest rates – what it means for savings and loans when they go below 0%

Christel Deskins

It’s not happened before in Britain, but there’s a real possibility that interest rates could go below zero in the not-too-distant future. Negative interest rates were considered by the central bank during a meeting in September, although no decision had been made yet. But the Bank of England has now […]

It’s not happened before in Britain, but there’s a real possibility that interest rates could go below zero in the not-too-distant future.

Negative interest rates were considered by the central bank during a meeting in September, although no decision had been made yet.

But the Bank of England has now told high street lenders to provide details on how they would cope if interest rates were cut to zero or even turned negative.

Deputy governor Sam Woods wrote to financial institutions across the UK saying they must be ready for such a move.

In theory, negative rates mean you’d have to pay banks for holding on to your money for you, rather than getting interest payments on your savings, while banks would hand you cash to take out a loan.

Of course, that’s in the most extreme scenarios – with the reality likely to look a little different.

But negative interest rates themselves are far from theoretical – with them being used in other countries for several years including in Japan and on mainland Europe.

The Bank of England is seriously thinking about taking rates negative

The idea behind negative interest rates is to encourage banks to increase lending and so get the public spending money to boost the economy.

Getting more cash out of savings accounts and into the hands of shops, tradesmen and other workers could also help boost their earnings and stop firms going bust or laying people off

Equally, incentivising banks to lend money by making loans cheaper can mean everything from more people moving home, more holidays and more cars sold.

The days of big rates on savings are long gone

But even were rates to drop below zero, it’s unlikely families and household savers will have to pay to have their money in a savings account or handed extra cash when borrowing.

The first point to make is that a lot of loans, mortgages and savings products are fixed-term deals.

That means the rates won’t change until the term ends, no matter what the Bank of England does.

In fact, even variable-rate mortgages frequently have clauses saying interest payments will never fall below zero.

Banks set rates based on far more than the Bank of England’s decisions

Miles Robinson, Head of Mortgages at  online mortgage broker  Trussle, said: “The current Bank of Eengland base rate is already at its lowest level on record (0.1%) and it’s unlikely that it will fall low enough that mortgage lenders are paying people to borrow money.

“As such, negative interest rates probably won’t have a huge impact on the housing market.”

Other loans – such as credit cards and overdrafts – have interest rates charged based on the cost of administering them, the chances of people not paying them back and a profit margin for the lender.

That means they are unlikely to get a lot cheaper – even if interest rates fall into negative territory.

What it almost certainly would mean is that savings rates would drop to effectively zero – with past cuts in the UK base rate passed on to people saving money far faster than loan rates fall.

Savings rates would be bound to fall

In that scenario, the only way to make money on your savings would be to take some risk with them – either putting them in the stock market or investing in other assets or businesses that make profits.

Sarah Coles, personal finance analyst, Hargreaves Lansdown, said: “Banks are very wary about introducing [negative rates on personal savings acccounts], because there’s a risk people will withdraw their money and either spend it or keep it lying around the house.

“So we’d be more likely to see charges being introduced on accounts, to recoup the cost of holding money without specifically charging interest.

“Savings accounts would be likely to offer even lower returns, so if you’re considering fixing some of your savings for a period, and locking in a rate, don’t put it off in the hope that there might be something more generous on offer in future.”

Of course, the value of savings goes far beyond the interest paid on them – providing a safety net to cover unexpected expenses as well as a loss of income – but as a source of income they could effectively become pointless.

What the Bank of England asked lenders to tell it

The Bank asked for people’s action plans

In the letter to firms, Sam Woods wrote: “We recognise that a negative policy rate could have wider implications for your firm’s business and your customers.

“The Bank and PRA (Prudential Regulation Authority) will consider the wider business implications, including on financial stability, safety and soundness of authorised firms and pass-through to the wider economy.

“This letter, however, is seeking information to understand firms’ operational readiness and challenges with potential implementation, particularly in terms of technology capabilities.”

He added: “As part of this work, we are requesting specific information about your firm’s current readiness to deal with a zero Bank Rate, a negative Bank Rate, or a tiered system of reserves remuneration – and the steps that you would need to take to prepare for the implementation of these.”

The questionnaire asks firms of their readiness for rates of zero, a tiered approach used in other countries and interest rates with large decimal places – citing an example of a Base Rate of 0.00001%.

Woods was also keen to stress in the letter that the fact he was asking for details is “not indicative that the MPC (Monetary Policy Committee) will employ a zero or negative policy rate… This engagement is not asking firms to begin taking steps to ensure they are operationally ready to implement a negative Bank Rate”.

Banks and financial institutions have been asked to respond with answers on costs, technology requirements and details of potential consequences by November 12.

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