July 15, 2021 by Dymphna 1 Comment

Revealed: APRA’s secret plan for negative rates

Negative rates could be a thing

I’ve heard a few people say that the only way for interest rates from here is up.

Let’s make something clear: It’s not.

Rates could still go lower. Rates could go negative.

I know that sounds radical, and it is. But we’re all set to go.

It was actually revealed last week that APRA asked the banks to make sure they were ready to handle a negative rates universe.

From The Australian Financial Review

The prudential regulator wants banks to be prepared for zero and negative interest rates, and has called on them to take all “reasonable steps” to ensure their technology systems can deal with extreme monetary policy settings.

… APRA said at the very minimum, banks should “develop tactical solutions” – short-term fixes to create workarounds on existing systems – to implement zero and negative market interest rates and cash rate by April 30, 2022. It wants this done for all products referencing the cash rate or a market interest rate. This includes business lending, residential mortgages, personal loans and credit cards.

Let me talk you through how negative mortgage rates might become a reality…

The key to understanding this is understanding what banks actually do.

The high-school version is they get money from depositors (who they pay interest to), and they then lend it out to borrowers.

This isn’t wrong, but it’s only part of the picture.

Mostly, the banks borrow money from domestic and international capital markets. They borrow money like you and I borrow money, and they have to pay interest just like we pay interest.

They then lend that money on to borrowers.

The difference they get between what you pay them, and what they pay the markets, is what they make as profit.

In that sense you can think about banks as merchants of money. They “buy” money at a particular price, and then “sell” money on at a premium, keeping the margin as profit.

Ok. That all make sense?

Now, what’s changed is that banks are able to get money at a much cheaper price these days.

Much, MUCH cheaper.

And that’s because the RBA has dropped the official cash rate (the baseline for all rates in the market) to just 0.1%.

But the RBA is just making it up. 

So what if the RBA decides that rather than 0.1%, they say the TFF rate is going to be -0.5%, or -1.5%?

That is, what if they say to the banks, we’ll pay you to take this money off us, so long as you lend it on to borrowers?

The banks would then have the ability to pay you to take the money off them (i.e a negative mortgage rate), and as long as the RBA is paying them more than the banks are paying you, they’re making a profit.

And that’s how negative mortgage rates might happen. The infrastructure is already in place and it’s already functioning.

And the reality is we’re already seeing the first wave of nations cross the river over to negative rates. 

The European Central Bank started with 0.1% funding for banks in 2014. By 2016 the rate was -0.4%. And now it’s -1.0%.

So look, I’m not saying that we’ll definitely see negative mortgage rates any time soon.

But it is not true to say that the only way for rates is up.

That’s just not true.