What are negative interest rates and how do they work?

RACHELLE YOUNGLAI– ECONOMICS REPORTER

What do they mean for banks?

If banks have to pay to park their money with the Bank of Canada, this could eat away at their profits. According to a Bank of Canada discussion paper, banks with a larger retail business would be hit harder than those focused on corporate banking, as it may be easier to “pass negative rates through to corporate clients than to retail clients.”

“Banks could mitigate a decline in profitability by increasing charges on accounts, raising fee-based revenue or reducing deposits, but these efforts may not be fully offsetting,” the discussion paper said.

What do they mean for the economy?

Think of it as an added incentive to get banks to do something with their money – that is, to lend or invest. Negative interest rates punish banks for parking their excess funds at the Bank of Canada by making it more expensive for banks to hoard cash. The deposit costs are supposed to encourage the banks to lend or invest.

Assuming banks will have no appetite to lend during an economic crisis and consumers will be unwilling to borrow, the negative interest rate is supposed to encourage lending and borrowing.

“It effectively means the whole structure of interest rates will go lower than where we are,” said Doug Porter, chief economist with the Bank of Montreal.

So, if the Bank of Canada slashes rates to minus 0.5 per cent, that would theoretically mean that the banks would lower their prime lending rates to between 1 and 1.15 per cent. However, Mr. Porter said, this would be an act of desperation. “When we get down to these levels, each additional cut tends to have less and less impact.”

What does this mean for consumers?

So, the bank isn’t going to pay you to borrow funds, but you will essentially get to borrow money for free.

The cost of borrowing will be close to 0 per cent. “If you have a job and you are secure and you are doing great in this kind of crisis, you are laughing because you can borrow at zero,” said Benjamin Tal, deputy chief economist with CIBC.

At the same time, banks may decide to pass on the extra costs to their customers and charge them to safeguard their cash.

So what is a depositor supposed to do? You can take your money out of the bank and invest it in an asset, such as a bond, or you can bring it home and store your cash in your mattress.

“You definitely have to invest in a good alarm company. Are you going to be comfortable every time you leave the house if you have thousands of dollars there?” Mr. Tal said.

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