Most of the world's central banks have injected massive amount of liquidity, or money, over the course of last couple of years. Through rate cutting and quantitative easing, CB's have been trying to crack credit dead lock by making money available to major commercial banks in their respective jurisdictions. So far all these efforts had little effect on loan availability. Banks have tightened their lending standards and money is slow to flow to business.
Situation causes great concern to financial authorities. Unprecedented stimulus packages, combined with interest rates at or near 0%, leave very little room for farther monetary easing. At the same time, they must come up with some kind of viable exit strategy. Governments have assured taxpayers that bailout money would largely be recovered, while central banks must demonstrate ability to clear their books, even though it would be through "creative accounting".
Large banking institutions are accused of hoarding cheap money and not passing it along into economy. This is exactly what happened in Japan few years ago when Bank of Japan instituted its easing policy. Banks in that country simply refused to lend money in fears of over worsening economic conditions. They didn't want to left holding the proverbial bag. Now it became a world wide problem.
Swedish national bank, the Riksbank, have introduced a novel idea of "negative interest rates". This is believed to be the first time a major central bank took such a drastic action. Current rate in Sweden is minus 0.25%. Officials hope that by charging commercial banks rate on deposits, it will force them to start lending money to business and individuals, thus jump starting the economy.
Banks are required to keep certain percentage of their money on deposit with central bank. Now, instead of earning interest on these deposits, banks will have to pay Riksbank 0.25% for this. This means that the more loans they make, the less money they must keep with central bank and, ultimately, pay less in interest. Riksbank thinks that making additional loans will be in the financial and business interest of commercial banking institutions.
So far Swedish authorities are the only ones to employ this controversial tactic. However, some other central banks also view it as an additional step they could take. Among them is Bank of England. The governor, Mervyn King, hinted that he could follow Riksbank's lead. Others are waiting to see if this action is producing results desired, without serious side effects.
Critics of this move claim that outside of creating controversy, launching negative interest rates will do nothing to truly improve lending conditions. Any additional costs accrued by banks will simply be passed on to borrowers in the form of raised rates and extra fees. As a matter of fact, it could force banks to invest more money into debt instruments, leaving less available for direct lending.
Currency traders should watch closely Swedish Krona over next few weeks. Nobody knows what to expect, since the negative rate situation is unique. Behavior of SEK could easily give clues to what can expected from other currencies, should more central banks step into that territory. And this could happen fast, if we see an up tick in lending by Swedish banks.
