Negative deposit rates are not a dream

Quantitative easing broke the balancing mechanism between bank leverages and deposit rates. During a recession, quantitative easing boosts deposits although banks contract loans.

• Traditional Mechanism:In normal banking cycles, deposit rates are balanced by leverage. Banks raise deposit rates when they need funding to expand loans and lower them during deleveraging.

• QE Disruption:Quantitative easing increases deposits even when banks are not lending, creating excess reserves. After 2020, the Fed’s interest on excess reserves (IOER/IORB) fell to ~0.1%, reducing banks’ interest income.

With IOER near zero, banks face deposit surpluses and may lower deposit rates to reduce funding costs.

Negative rates become feasible if depositors tolerate small charges for “money storage.”With IOER near zero, banks face deposit surpluses and may lower deposit rates to reduce funding costs. Negative rates become feasible if depositors tolerate small charges for “money storage.”

1. Leveraging and the Traditional Deposit Rate Mechanism

In a normal banking cycle, banks finance lending through deposits. As bank leverage rises, so does demand for deposits, prompting competition to increase deposit rates. This, in turn, expands deposits and balances the rates. Conversely, during deleveraging, banks reduce their loan portfolios, need fewer deposits, and deposit rates fall. But the decline is limited, since deposit supply also contracts—maintaining a rough balance.

2. Quantitative Easing and the Breakdown of the Self‑Adjusting Mechanism

Quantitative easing (QE) disrupts this mechanism by injecting liquidity into the system: deposits rise while lending may contract. Banks accumulate excess reserves, often idle on balance sheets. Until mid‑2021, the Fed paid interest on excess reserves (IOER), linking bank incentives to maintain reserves. However, IOER was cut to around 0.1% in 2020 when the federal funds rate hit 0.00–0.25% on March 15, 2020.

With interest on excess reserves (now called the IORB rate) near zero, banks found their interest revenue effectively eliminated—yet deposits continued accumulating due to QE.

3. Role of Supply and Demand in a Near‑Zero IOER Environment

As IOER remains close to zero, classical supply–demand forces reemerge to determine deposit rates. Banks facing deposit surpluses are incentivized to lower deposit rates. Depositors, not paying for storage, continue depositing unless deposit rates fall below zero. A negative deposit rate forces them to either withdraw cash or accept a charge for bank custody.

Banks may adopt negative rates if elasticity of deposit supply is such that net earnings exceed the near-zero reserve income.

4. Experience and Evidence from Past Negative Rate Policies

Empirical evidence shows how negative interest rate policies (NIRP) affect banks:

• In Europe, banks relying heavily on deposit funding saw their net interest margins shrink by ~18 bps due to negative rates—equivalent to nearly one-third of pre‑2014 return on equity.

• Across advanced economies, further cuts to policy rates below ~0.5% drag deposit rates to zero while compressing margins sharply, because banks cannot pass negative rates along without depositor flight risk.

• Some banks in Switzerland and Italy increased lending activity post‑NIRP implementation, particularly those with high excess reserves and deposit ratios. However, other studies suggest heterogeneity—some banks curtailed lending post‑NIRP if capital constraints existed.

5. Application to U.S. Banking and Fed Policy

Since QE began in 2020, U.S. bank excess reserves ballooned. Though FX data show aggregate IOER/IORB rates were reduced to 0.1% in 2020 and subsequently merged into IORB in mid‑2021, deposit volumes remained high while banks earned minimal interest. With IOER/IORB rates near zero, commercial banks lose the cushion reserve income once provided.

If the economy fails to recover robustly, banks could respond to deposit surpluses by implementing negative deposit rates as a revenue-generating measure—so long as depositor behavior tolerates it.

6. Other countries

1. Switzerland (Since 2015)

• Policy: Swiss National Bank (SNB) deposit rate: −0.75% (2015–2022).

• Impact:

  • Some large banks (e.g., UBS, Credit Suisse) passed negative rates to wealthy depositors—typically above CHF 500,000 or 1 million.

  • Corporate accounts often faced charges directly.

  • Bank profits pressured as net interest margins fell, encouraging banks to increase mortgage lending to offset lost income (SNB, 2022).

    
    

2. Euro Area (ECB, Since 2014)

• Policy: ECB deposit facility rate went negative in June 2014, reaching −0.50% in 2019, returning to 0% in 2022.

• Impact:

  • Banks initially absorbed the cost rather than pass it to retail clients.

  • Over time, corporate and large private clients began paying for deposits.

  • Some countries (Germany, Netherlands) saw retail thresholds (e.g., balances over €100,000) charged at −0.4% to −0.5% (ECB, 2021).

  • Stimulated bank lending modestly, but profitability pressures increased (Borio et al., BIS 2020).

    
    

3. Denmark (Nationalbanken, 2012–2022)

• Policy: First central bank to go negative: −0.20% in 2012, reaching −0.75% in 2020.

• Impact:

  • Some mortgage rates turned negative, meaning banks effectively paid some borrowers small amounts.

  • Corporate deposits charged first; some banks later extended negative rates to retail deposits over DKK 100,000–250,000.

  • Banks relied more on fee-based income to offset interest margin losses (Danmarks Nationalbank, 2022).

    
    

4. Japan (Bank of Japan, Since 2016)

• Policy: Introduced a −0.1% policy rate on part of excess reserves under its “three‑tier” system.

• Impact:

  • Retail deposits not charged negative rates due to strong cash preference.

  • Japanese banks increased foreign lending and government bond holdings to find yield.

  • NIRP compressed profitability, leading to consolidation pressures among regional banks (BoJ, 2021).

    
    

5. Sweden (Riksbank, 2015–2019)

• Policy: Repo rate dropped to −0.50%, deposit rate effectively negative.

• Impact:

  • Most retail customers were shielded, but corporates faced charges.

  • Banks responded by raising fees and extending more mortgage credit.

  • Riksbank later raised rates back to 0% due to concerns over housing bubbles and bank profitability (Sveriges Riksbank, 2019).

6. Past Success and Potential Future Risks

During the 2008 crisis, QE and low interest rates helped stabilize financial systems and revive lending. When policy rates rose later, interest paid on excess reserves encouraged banks to hold reserves—and lending resumed. But as rates climb, excess reserves may again feel unprofitable, especially compared to lending.

If economic recovery remains tepid, the Fed’s large balance sheet and abundant deposits create conditions where banks might experiment with charging depositors. Negative deposit rates may provide a modest boost in net interest margins, albeit with risks of deposit flight and reputational harm.

References

• Freriks & Kakes (2021): European banks’ margin impact under NIRP (~18 bp margin loss) suerf.org

• Ulate (2021): Framework of deposit-rate pass-through threshold at ~0.5%; effect on bank ROE Federal Reserve Bank of San Francisco

• Basten & Mariathasan (2018); Bottero et al. (2022); Demiralp et al. (2021): Lending response heterogeneity under NIRP boj.or.jp+1Federal Reserve Bank of San Francisco+1

• Borio et al. (2018), Jobst & Lin (2016): Mixed view on NIRP profitability impacts via margin erosion vs asset revaluation MDPI

• Federal Reserve data: IOER to IORB transition and federal funds rate collapse to 0.00–0.25% in March 2020