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You are here: Home / Investment News / Negative thinking: how NZ banks are prepping for sub-zero rates

Negative thinking: how NZ banks are prepping for sub-zero rates

July 12, 2020

Myles Allan: Mosaic founding partner

Even before the global economy went viral this March, the Reserve Bank of NZ (RBNZ) was softening up the market for negative interest rates – or least the idea of it.

For instance, the RBNZ touted the prospects of a below-zero official cash rate (OCR) in a paper on unconventional monetary policy published in May 2018.

“The experience of central banks so far suggests that central bank policy rates can be pushed modestly below zero with similar transmission to conventional monetary policy,” the RBNZ paper says.

And last year, RBNZ governor, Adrian Orr, went on record defending the superiority of negative rates over central bank asset purchases for monetary policy purposes – ahead of his ‘surprise’ 50 basis points (bps) OCR cut last August.

When the coronavirus crunch came this March, however, the RBNZ turned to large-scale bond purchases rather than drag interests below the, possibly temporary, floor of 0.25bps it established in the same month.

Orr said at the time while negative rates remained an option, it was one that would have to wait until the NZ banking system adjusted its dials accordingly.

He told media late in June that “only a handful of banks” were experiencing technical issues preventing the switch to negative rates, if required.

However, Myles Allan, founder of specialist consultancy firm Mosaic Financial Services Infrastructure, said that while the RBNZ no doubt have clear visibility of industry readiness, the negative rate technical conundrum was likely widespread in the NZ banking sector.

Allan said while bank core systems may be able to handle negative rates, the larger problems may arise in the many “peripheral” operations that channel transactions through the financial system. Notably, if implemented, negative rates would only apply to wholesale banking services.

“At first pass it might look do-able, but then you have to consider all the areas across the banking ecosystem where negative rates might set constraints,” he said.

The RBNZ is pushing for all NZ banks to be ready for negative rates come December 1, and most of them are committing considerable resources at meeting that deadline, Allan said.

Allan said the work involved in preparing bank systems for sub-zero rates is “likely larger than initially expected”.

The main problem is more deeply rooted in basic maths. In fact, there are two, subtly different, issues banks must ready their systems for.

As well as ensuring all affected systems (that will be limited to wholesale operations) can handle a minus sign without issue, banks must also factor in the possibility of a zero OCR.

“Dividing by zero obviously has its challenges,” he said.

According to Allan, the task at hand requires banks to identify every component in their systems where a negative or zero interest rate figure may cause problems and look for “tactical solutions”.

Tactically, he said banks will probably have to build many of the negative-zero patches in-house, although the experience of other jurisdictions – notably, in Europe and Japan – could prove instructive.

“But they should also use the opportunity to build longer-term strategic solutions – working with software vendors and third-party suppliers,” Allan said.

While NZ banks face the full brunt of the negative rate technical challenge, Allan said most financial sectors that interact with wholesale markets – including fund managers – would be impacted if the RBNZ turns the OCR red (or neutral).

Sensibly, neither Allan nor the wider Mosaic team would put firm odds on the prospect of the RBNZ imposing sub-zero rates.

“But everyone has to accept that there is now a real risk of negative interest rates,” he said. “From what we are seeing across the market the banks will be able to hit the December 1 deadline although it remains to be seen what any phase-two strategic measures will look like.”

 

 

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