What it means
Normally a bank pays you interest for the use of your deposit, and you pay the bank interest when you borrow. With a negative rate, the direction of payment reverses on at least some balances, so a deposit of $1,000,000 can shrink each year instead of growing.
The idea is that if holding cash is penalised, people and firms will invest it, lend it or spend it. The rate most often described as negative is the one a central bank charges commercial banks on the reserves they park with it overnight.
Banks then decide how much of that cost to pass on to customers. In practice many banks have shielded ordinary households from negative rates while passing charges to large corporate depositors, because they fear customers would withdraw their money in protest.
Negative rates ripple through the whole financial system. Government bond yields can fall below zero, mortgage and loan rates can fall very low, and the discount rate used to value future cash flows drops, which pushes up the valuations of assets such as property and shares.
Lenders, however, see their profit margin squeezed because they cannot easily charge depositors enough to cover their own costs. Finance teams react in practical ways.
Treasury departments may spread cash across more banks, move surplus funds into short-term government paper or money market funds, or simply pay down debt. Some firms prepay suppliers or tax liabilities to avoid holding cash that costs them money.
The main nuance is that negative rates are a policy setting and not a natural law. They were introduced by some central banks as an unconventional measure, and they can be reversed.
They also do not stop cash from being an option, since physical notes carry a rate of zero, which is why the charges on deposits can only go so far below zero.
In practice
Real-world examples.
Example
A manufacturer with $20,000,000 in operating cash finds its main bank now charges a fee on balances above $5,000,000. The finance director splits the excess across three other banks and a government money market fund. This keeps each balance under its charging threshold and avoids a bill of tens of thousands of dollars.
Example
A pension fund holds government bonds whose yields have dropped below zero. Its actuary notes that the fund must now earn returns from riskier assets to meet promised payments. The trustees ask the investment team to model how a shift of 10% of the portfolio into infrastructure projects would change the expected outcome.
Example
A property developer sees borrowing costs fall sharply when the central bank cuts its policy rate below zero. It refinances a $15,000,000 loan at a lower margin and starts two projects that were not viable before. The lower financing cost raises the projected profit on each project.
Formula
Calculation
Balance after one year = opening balance x (1 + rate), where the rate is negative
Suppose a company holds $1,000,000 in a deposit that carries a rate of -0.50% a year. The calculation is 1,000,000 x (1 - 0.005) = 1,000,000 x 0.995 = $995,000. The company has paid $5,000 for the privilege of keeping its cash at the bank. If the same company moved the money into an account at 0.00% it would keep the full $1,000,000.Case study
Seen in the real world.
Harbour Textiles is a fictional exporter that kept $8,000,000 in a single bank account for convenience. When the bank announced it would charge 0.40% a year on balances above $2,000,000 for corporate customers, the finance manager worked out that the cost would be $24,000 a year. This was illustrative of a charge that most staff had never noticed because interest rates had always been positive.
The manager opened accounts at two other banks, placed $3,000,000 into a short-term government securities fund, and used $1,000,000 to pay a supplier early in exchange for a small discount. The annual charge fell to almost nothing. The lesson for the board was that negative rates are a cash management issue as much as a central bank topic.
Watch out
Common mistakes.
- Assuming negative rates mean every borrower is paid to borrow. In reality most lenders still charge a positive rate on loans, because their margin, risk and costs must be covered.
- Believing ordinary savers always pay when the central bank rate goes negative. Banks often absorb the cost or charge only larger balances, so the effect varies a lot by customer type.
- Treating a negative rate as a sign of a healthy economy. It is usually used when growth and inflation are weak and policymakers want to encourage spending.
Questions
People also ask.
Why would anyone deposit money at a negative rate?
Because holding large sums of physical cash can be costly, unsafe and impractical, so some depositors accept a small charge in return for security and payment services.
Does a negative rate affect company valuations?
Yes, because lower discount rates raise the present value of future cash flows, which tends to lift valuations, though the effect depends on the reasons the rate fell.
Can a negative rate be applied to a loan?
Yes, in some markets a floating-rate loan can have a negative base rate, though lenders usually add a margin or set a floor at zero so the borrower does not receive net interest.
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