UPDATED October 14, 2020: As the Bank of England asks lenders if they are prepared for negative interest rates, we consider five key issues for financial services in a negative interest rate environment. By Financial Services Faculty commissioning editor Brian Cantwell.

Since the start of the year, negative interest rates have loomed across the news as the Bank of England wrestles with the policy as a way to stimulate the UK’s flagging economy.

Most recently, Sam Woods, CEO of the Bank’s Prudential Regulation Authority, has written to lenders to request information about their operational readiness for a range of policy moves – including the implementation of a zero or negative bank rate.

Interest rates are currently at 0.1%, and the ongoing challenges of the pandemic and the increasing likelihood of a no-deal Brexit could see the Bank reach into its toolbox for negative interest rates.

When rates are negative, it costs banks to hold money, which encourages them to lend it out. There are fears that the knock-on effect of the pandemic on the economy could become another credit crisis, meaning the negative rates policy would be a useful aid against this effect.

BoE Governor Andrew Bailey had mooted negative interest rates after the pandemic took hold. The idea was reconsidered during the summer following positive numbers on inflation. However, as a second wave of COVID-19 takes hold the issue has raised its head again as a growing possibility.

The deputy Governor of the BoE Sir Dave Ramsden told the Society of Professional Economists (SPE) he thought negative interest rates would be a less than effective tool to stimulate the economy. Interest rates are very low already, meaning negative interest rates might not have the desired effect. In his opinion, reducing bank income is a risky move at the moment given they are facing potentially large losses from the pandemic through defaulting loans.

It is clear that the BoE takes the policy very seriously and may not be sure about its unintended consequences, or what the next policy steps are should deflation take hold. But what are the key factors feeding into the Bank’s decision? ICAEW’s Financial Services Faculty looks at five points the BoE will take into account when making a final decision on the matter.

It will reverse the status quo in banking deposits

In a world of negative interest rates, customers’ deposits may see no interest paid on them, and in some cases, interest will be charged for the bank to hold investors' money. In Switzerland, UBS announced that it would levy a negative interest rate on wealthy clients who deposit more than two million Swiss francs.

It could threaten financial stability

Banks in Europe may have to seriously reconsider their business models or contract in the face of persistently negative interest rates. In Denmark, where negative interest rates have persisted for years, the Danish banking regulator has warned that negative rates could drive banks there into pushing riskier savings products to customers, after it was forced to report Danske Bank to police for its FlexInvest Fri product.

It has risk associated as a regulatory fiscal policy

The ECB has an extreme monetary policy called the negative interest rate policy that tackles a deflationary economy, but it can harm financial stability. This is because it encourages disintermediation in the banking industry that can destabilise a bank’s revenue generation, as savers seek returns from other financial products via non-banks and asset managers.

Insurers are already suffering through the Ogden rate

Insurers are already seeing the effect of negative rates through the Ogden rate, amplifying the effect that negative rates could have on the insurance industry. The Ogden is an assumption about how much interest the accident victims would earn if they were to invest their compensation. The higher the Ogden rate, and hence the assumed return, the lower the lump sum paid by the insurance companies. The rate has been set at minus 0.75% since 2017 but was reviewed this year. Insurers had expected the rate to rise to somewhere between zero and 1% during 2019, but it stayed at minus 0.25%.

Mortgage fees could become more expensive

The first negative interest rate mortgage was launched in Denmark by the country’s third biggest lender Jyske Bank, which is offering ten-year mortgages at -0.5%. Every month the outstanding mortgage balance will be reduced by more than the repayment amount. The bank’s economist Mikkel Høegh said the bank was able to borrow from money markets at negative rates and is simply passing that on to customers. As a result, the mortgage carries significant fees and so it is likely that the mortgage holder will, over the lifetime of the mortgage, pay back more than they borrowed – and fees further reduce the affordability at the point of sale of the mortgage.

Further points to consider for accounting with negative interest rates:

• Consider complications for employee pension valuation if using a negative discount rate
• Financial instruments - if negative, does it meet the solely payments of principal and interest (SPPI) test?
• Expected credit losses (ECL) - how to treat unpaid interest?
• Hedge accounting - if either the loan or the hedge is floored at zero then is hedge accounting impaired?
• How do banks present negative interest payments in their accounts?
• Consider how to apply negative rates as the relevant discount rate in many accounting standards