British banks are confronting the European import of subzero interest rates that could damage profits already weakened by the coronavirus pandemic as the Brexit divorce rumbles toward its rocky end.
Bank of England officials have begun talking openly about going negative, erasing the red line drawn by former Governor Mark Carney. His successor, Andrew Bailey, told lawmakers on Wednesday, "I have changed my position a bit" and refused to rule it out.
His comments highlighted the intensifying debate, with inflation slowing to the lowest level since 2016 and the nation selling debt with a subzero yield for the first time. For British lenders, negative rates would be just another sign of how Covid-19 has upended their world. Their earnings battered by the lockdown economy — from rising bad loans to property-market paralysis — banks' core business of taking deposits and making loans now faces a squeeze.
Going below zero from the current benchmark of 0.1% could cut domestic banks' pretax earnings by 50% to 80%, Bank of America predicts.
"The big banks will hate negative rates," said Paul Lynam, a former senior official at Royal Bank of Scotland Group and now chief executive of Secure Trust Bank.
Silence
Unlike their counterparts in Europe, British bank executives have avoided a confrontation with Bailey, who'd been a financial-industry regulator since 2013 before succeeding Carney this year. They've stayed silent on negative rates; even the industry lobby, UK Finance, has yet to take a stand on an issue that could hammer their bottom line.
"If you were thinking it couldn't get any worse," analysts Rohith Chandra-Rajan and Alastair Ryan wrote this week, "negative rates would have a much longer lasting impact on U.K. banks' profitability than current concerns on credit quality."
That helps explain Carney's opposition throughout his tenure, as counterparts in Scandinavia, Switzerland and the euro area moved below zero. Upending the economics of deposit-taking would undermine the member-owned building societies that constitute an integral part of the the U.K. financial industry.
Fed stress
A similar debate has broken out in the U.S., with some traders betting — against denials by policy makers — the Federal Reserve will have to go below zero. A quarter-point cut to zero for the upper bound of the Fed's main policy rate could lower annual income by about $1 billion to $2 billion for each of the biggest banks, according to their latest quarterly filings.
For its part, the European Central Bank has argued that the economy — and thus lenders — would have been worse off without negative rates. A section of its March Economic Bulletin contained an analysis that concluded "overall, negative interest rates have supported economic activity and ultimately contributed to price stability."
The ECB acknowledged that profit margins at lenders have dropped but said that's been more than offset by higher lending volumes. Lower interest rates make debt more sustainable, it said. Still, it acknowledged that negative rates might ultimately turn counterproductive if held for too long, as banks protect their profit margins and in doing so undermine the transmission of monetary policy.
The U.K.'s largest retail lender, Lloyds Banking Group, had been targeting a margin of 2.8% for 2020 before coronavirus struck, but warned alongside its first-quarter results that its previous guidance was "no longer appropriate." Other banks told a similar story.
Since Bailey's arrival at the central bank, just as the full force of the pandemic was starting to hit the U.K., the doubts expressed by Carney have become less definite.
From his first comments as governor, Bailey has refused to rule out any policy tools, including negative rates, but he has also said they are "not something that we are currently planning for or contemplating."
Bailey's remarks to lawmakers went even further, saying the policy was under "active review."
Comments from others on the nine-member policy committee highlight the direction of the debate — if not policy. Chief economist Andy Haldane said in an interview published over the weekend that officials need to be looking at negative rates since the economy is so weak and the benchmark rate is already essentially zero.
Policymaker Silvana Tenreyro told a webinar Monday that cutting below zero has had a positive effect on transmission in Europe, but highlighted that there are U.K.-specific considerations around financial institutions, implementation and communication.
Bailey sounded "consistent" with such views and his comments turned the dial in the debate, wrote JPMorgan Chase economist Allan Monks. Still, it will take policymakers "a while" before committing.
