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There are many unknowns. ALM scenario modelling systems will be working overtime.
Asset and liability management (ALM) managers have been modelling interest rate floors for several years, but do we really know what will happen to savings if a negative rate were applied? Speculation has been mounting that the Bank of England might implement negative interest rates this year to pump money into the economy, enabling hard-pressed businesses to keep or recruit staff and invest in research and development, thereby accelerating the recovery.
This has never been seen previously in the United Kingdom. So what can ALM managers learn from the experiences of negative base rates in other countries? And how far would the lessons apply to the UK market, based on what we know about current and past behaviour?
Some of the big unknowns for ALM managers are, ?What happens if negative rates are applied to savings? Will all, some, or none of your customers withdraw their funds?? Negative interest rates on savings balances are currently unheard of. However, there are examples around the world of negative rates for larger balances as well as increased fees. The real questions are, ?When are negative rates on savings balances appropriate? What about negative rates on lending? With additional fees, is the return to the bank still positive and is the overall rate to the customer transparent??
The situation is different in the United Kingdom, where bank charges are rarely applied to retail customers, particularly for example on current accounts. Nonetheless, banks must plan for the possibility of negative base rates, and what happens when rates go up again. ALM managers should consider the following:
? Would an interest rate shock trigger a mass withdrawal of funds?
? Is the real floor for retail deposit interest rates zero?
? Can we compensate for zero or negative rates with fee income?
? What is allowed under the terms and conditions of various products?
? How will risk appetite/balance sheet structure change?
With no previous occurrence in the United Kingdom, it is difficult to guess how customers will respond. Additionally, what about the impact of the large increase in retail deposits that have built up through the pandemic? If there is a steep V-shaped recovery after Covid-19, does this raise a strong probability that a crash will occur soon afterwards?
The future is uncertain. But negative interest rates are a distinct possibility?and ALM managers should understand the planned customer pricing and consider the likely impact on customer behaviour. Given all the imponderables, they will need to model a broad range of scenarios. Do they have the right systems to meet these challenges?
Nicolas Kunghehian, Director, Solutions Specialist, Moody?s Analytics