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Negative Interest Rates Could Lead to Bank Runs

Written By Geoffrey Pike

Posted February 2, 2016

bojrunLast week, the Bank of Japan (BOJ) announced that it will join a few other central banks of the world in implementing negative interest rates. Specifically, the BOJ will charge a fee to banks for deposit money held as excess reserves. At this time, the banks will not be charged for their required reserves.

The zero interest rate policies (ZIRP) of central banks have been a topic since 2008. Now we have to talk about NIRP – or negative interest rates.

This decision by the BOJ has a lot of implications and we will have to see if it takes this negative interest rate further into negative territory. For now, it is just minus 0.1%, so barely below zero.

For this article, I just want to focus on one possible implication of this new policy by Japan’s central bank.

Since banks will now have to pay a fee (a negative interest rate) for excess reserves, they are obviously not going to want to keep these excess reserves, at least on the margin. The idea is to get the banks to lend the money. But what if there are few borrowers who are not deemed risky? A bank may rather get charged 0.1% interest rather than make a risky loan where it could lose a lot more.

Another option is for banks to find other places for the money, such as in investment securities. Again, this is a risk issue, and the banks are dealing with money from depositors who expect the money to be available on demand.

Eventually, the natural response from the banks will be to pass this negative interest rate on to its depositors. Why would banks willingly accept money that they know will only sit there and lose money?

Therefore, it should not surprise us if Japanese banks announce that they will be charging their customers (depositors) a fee for basic banking services, especially where the depositors expect to be able to redeem their deposits on demand. The banks could just charge a 0.1% fee to offset the fee charged by the central bank.

But then this will lead to another effect, mainly having Japanese depositors avoid putting money into Japanese banks. Certainly some could withdraw cash from the banks and essentially store it under a mattress. This would actually have the opposite effect of what the BOJ is trying to accomplish.

But let’s face it; most people don’t want to store their money under their mattress. This is especially true of wealthier individuals, who are the ones who matter the most. They will be looking to park their liquid money in a safer place than under their mattress.

Following China

This new policy of negative interest rates may result in something similar to what we are seeing from wealthy Chinese investors. Some Chinese investors are sending their capital outside of China to buy up investments in other “safer” areas.

This includes real estate in California and expensive Canadian cities. In other words, Chinese investors are contributing to the biggest bubble areas of North America. But when you compare these investments to what is available in China, they really probably are a lot safer. They would have been better off finding properties in Texas and Florida over San Francisco and Vancouver, but they are all better than Chinese real estate.

In China, there are much tighter government controls, making it more difficult for capital to be sent overseas. In Japan, the markets are freer, relatively speaking.

If Japanese depositors are going to be charged a fee to put money in the bank, they are going to look elsewhere. They could choose to buy stocks, but this is far from safe. Stocks had their initial boost after the BOJ announcement, but we don’t know if that will last. It may turn out to be a one-time or short-term boost.

There are Japanese government bonds, which pay almost nothing. But then you are exposed to the risk of higher rates, or you will be locking up your money for a long period of time with virtually no return.

For people in Japan with money, there are not a lot of options. It would not be surprising to see the wealthier Japanese people sending their money out of the country. Whether they buy American stocks, American real estate, or even U.S. government bonds, it seems it may be a better deal than anything currently in existence in Japan.

The problem is that they would be converting their money from yen to U.S. dollars (or whatever currency is used by the country they are investing in). It is something of a carry trade. This will only serve to drive down the value of yen further. Maybe this is what the BOJ initially wants, but what if it gets out of control? Eventually, the BOJ would be forced to stop the selling of yen by propping it up. It would be somewhat similar to what has happened in China.

Central bankers everywhere are a bunch of Keynesians. The central bankers in Japan seem to be even worse than normal. They are trying desperately to create positive price inflation – as if this is the magical cure for its slumping economy. Its massive money creation hasn’t done the trick, so it is trying to get banks to lend out the newly created money. It is apparent that the BOJ is not interested – at least right now – in buying up even more massive quantities of Japanese government debt, which is already astronomically high.

Unfortunately for the BOJ, and the people of Japan, there are going to be several unintended consequences from these policies, including its latest policy of negative interest rates. It is going to set up something of a quiet run on the banks, as depositors flee negative interest rates and look for yield in other places – likely other countries.

Japan is already in a hole. The BOJ keeps digging it deeper.