In recent weeks, several briefings have referred to the prospect of increasing levels of losses for banks from loans that have gone bad. These were reinforced this week when Isabel Schnabel, an executive board member of the European Central Bank (ECB), gave a warning that there were likely to be increased levels of write-offs by banks in the eurozone area. She pointed out that banks were being faced with a double-whammy as alongside increased loan losses low (in fact negative) rates of interest will further depress earnings. She also pointed out that structural changes to European banking were needed; in summary, she suggested that there were too many banks and there was a need for a degree of consolidation to help improve the picture and increase levels of profitability.
The policy of negative interest rates is not without its critics. Investors will complain that they receive next to nothing for investing their money whilst sometimes profligate borrowers are being bailed out; yet in the current climate that seems all too simplistic. The dramatic events of the pandemic were a total shock; though so too were those of the financial crisis of 2008-9. In some ways the aftershocks of that previous crisis have continued to ripple as the last decade has been characterised by historically-small levels of interest, albeit recently they have reached unprecedently low levels. There is in fact little sign of international consensus on the policy of negative interest rates which essentially charges investors for the privilege of keeping their money in safer central banks. Whilst the Bank of England has openly discussed the possibility of negative rates, in the US the Federal Reserve is not a fan and Sweden recently abandoned the policy. Ms Schnabel however is openly supportive of it, arguing that it has succeeded in stimulating the economy. Yet even she conceded that it is likely to come under increasing scrutiny in the future, saying that 'in spite of the ECB's experience with negative interest rates, a persistent period of negative rates may pose additional challenges'.
This is not some mildly interesting (or not) academic issue. We have become acutely aware of how dependent the wider economy is on the financial viability of the banking sector. The 2008-9 crisis resulted in an unprecedented (back then anyway) bailout which emphasised this inter-dependence with in effect banks being considered 'too big to fail' with concomitant repercussions on broader economic policy. In reality measures like negative interest rates are just a continuation of this trend, albeit prompted by new issues in the current circumstances. The previous crisis was also prompted by loans that went bad, though back then it was the collapse of the sub-prime mortgage market that was one of the major catalysts. Low profitability for banks means lower dividends; and whilst there is a tendency to have little sympathy for super-rich investors who get their fingers burnt it is worth reminding ourselves that anyone who is relying on future pension pay-outs to fund their retirement is also potentially affected. This is a very big policy issue with wide-ranging repercussions and therefore we need to keep an eye on it as it develops.
Wayne Bartlet is an author for accountingcpd. To see his courses, click here.