The spectre of negative interest rates

20 Apr 2021

In early February, the governor of the Bank of England (BoE) Andrew Bailey, told banks and building societies they have six months to prepare for negative interest rates.

The BoE made it clear that this would not happen if, as is predicted, the economy begins bouncing back after the MPC-anticipated 4% fall in GDP in Q1 2021. So, all eyes will be on the level and speed of recovery from this month as the effects of the easing of lockdown #3 feed through to economic activity.

But how do banks and building societies prepare for being charged by the BoE for holding their excess cash deposits for safekeeping?

It's likely that the one in 10 mortgage holders still on variable rates will see the interest rates they are paying fall close to zero but if you read the T&Cs on most variable mortgage agreements they will not be paying you to borrow their money. So, there will be no big change there.

Bank savings account charges may rise

What about in savings deposits? We are likely to see banks offsetting anticipated losses incurred in negative interest rate regime by charging those with substantial deposits to hold your money. For a taste of things to come in negative interest rate land, you have to look at the behaviour of banks in the Eurozone, as well as in Switzerland, Denmark, and Japan where negative interest rates already operate.

UBS, for example, recently announced that it will charge clients with cash balances above 250,000 Swiss Francs (CHF) or approximately £200,000, a 0.75%pa interest rate fee from July 2021. Currently, the threshold for making this charge only hits the wealthiest depositors with more than £435,000 held on deposit. The only question then is what is the threshold at which your bank will begin charging?

However, it may not be that simple. Normally, you would not expect clients with ‘cash flow monies' in normal current accounts to see negative interest rates being charged. However, banks such as HSBC who are running at a considerable operating loss in Europe right now, are, according to The Independent, in the midst of reviewing the introduction of charges for ordinary current accounts already. Will a move to negative interest rates trigger that decision? We may see high demand for the new Alan Turing £50 note if savers decide that it's free to hide cash in their homes.

The same behaviour may feed through to pensions and other platform investments. What appears as ‘cash' on a client's platform statement is actually deposited by the platform at one or more banks, so we must expect that they will be passing those interest rate fees through to their own savers.

TFC timings?

What's perhaps more interesting for you as an IFA is that negative interest rates could easily affect some of your clients weighing up decumulation decisions. For example, you may want to discuss with them the timing of taking that tax-free cash lump sum. Bear in mind it's possible that if they put that cash into their bank or building society in the next six months, they might be charged for keeping it there, while simultaneously contending with inflation eating away at it.

Review ‘potting'

‘Potting' strategies, which some IFAs recommend for retired clients, may be less attractive if holding up to three year's future pension withdrawals in cash means not only sitting out any investment growth but also paying banking fees on the excess cash holdings.

It was perhaps a great strategy in the dark days at the start of the 'great recession' between August 2008 and March 2009. Equally, it was not a bad plan to help weather the coronavirus crash which officially started on 20 February and ran until 7 April 2020.

However, the danger now is that the cash pot becomes an increasingly leaky pot as it's not only impacted by the prospect of higher provider charges on cash deposits, but also by inflation.

More positively, negative interest rates are all in a day's work from a pensions administration point of view. Statutory Money Purchase Illustrations have been using negative interest rates during the retirement period for some time.

However, to avoid frightening the horses, several schemes simply tell members that they use any negative lower assumptions because it's required by law. Perhaps it's time for a little more explanation to avoid negative outcomes as the likelihood of seeing negative percentage ‘growth' numbers rises?

Avoid Y2K moment

That said, it's worth running some tests to make sure, that if you are going to need to show negative interest rates on deposits, your systems can cope with it. You don't want that moment to be your own Y2K event where suddenly deposit values cannot be shown or reveal incorrect numbers. You may also need to add re-assurance messaging literature to ensure that clients do not react in ways that are unexpected and detrimental to their retirement savings prospects.

Perish the thought that it might stimulate more than the steadily rising numbers of policyholders fully withdrawing their pensions at the first time of access. In the latest FCA figures for tax year 2019/20 there were 440,000 policyholders fully withdrawing pension monies at a total value of £5.7bn.

From an advice perspective, it may be tempting to recommend moving more of those cash pots into higher risk, higher return investments. For those looking for safety from market turbulence, corporate bonds may seem a more attractive home than cash. However, positive returns from bonds can be eroded by defaults, whereas cash in the bank will always be protected by the Financial Services Compensation Scheme.

by Adrian Boulding, Director of Retirement Strategy at Dunstan Thomas
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Adrian Boulding
Director of Retirement Strategy at Dunstan Thomas