A Pandemic of Negative Interest Rates: Banks and Their Clients Will Have to Adapt to a New Normal

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The coronavirus pandemic and lockdown have made life difficult for credit institutions and their clients. Citizens’ incomes have decreased, which can lead to an increase in bad debts, and a decrease in the key rate to support the economy makes deposits less and less attractive and deprives banks of an important resource. Banks are compelled to search for new ways to earn money, which carries additional risks, says HSE Banking Institute Director Vasily Solodkov.

The pandemic has given further impetus to trends that had already taken shape before the pandemic. Thus, the need to respond to new challenges presented by the pandemic has spurred growth in the remote services sector. Banks needed to continue serving their clients without interrupting operations while simultaneously restructuring their business processes within a short time span. And today, many banks still do not operate onsite in their offices. Most likely, this trend will continue, although offices will not disappear completely. For example, how do you put money or valuables in a banking cell without an office? Another factor is that it is more convenient for clients to discuss unique problems or issues directly with a bank employee rather than receive automated reply messages on an online forum.

Vasily Solodkov

© HSE University

The crisis has forced national governments and central banks around the world to launch their printing presses and cut rates, which were already negative in several countries before the pandemic. In other words, banks have to pay to keep their excess reserves stored at the central bank. According to the ECB and the FRS, this trend will continue for many years. Banks therefore need to prepare themselves for an extended negative interest rate environment and decreased deposits, and they will have to learn how to make money beyond the traditional confines of banking.

Banks’ attempts to compete with giants of the IT sphere and online trading, as previously mentioned by Sberbank CEO Herman Gref, or to develop other areas, give rise to new opportunities as well as new challenges

On the one hand, the more areas of activity a business entity has, the less risks there are. On the other hand, it is not for nothing that central banks in most countries oppose banks’ growing engagement in activities beyond the banking sphere and acquirement of non-core assets. Regulators are aware that a lack of experience in developing platforms for online commerce or in the grocery delivery business increases the risk of failure in these businesses. And all deposits made by individuals at a bank, as a rule, are insured (in Russia they are guaranteed by the Deposit Insurance Agency). Central banks oversee banking, but not adjacent industries. It is difficult to assume that they will become regulators not only in the monetary sphere, but also, for example, in floriculture or delivery services. Let's imagine that a bank is creating a flower farm. If it goes bankrupt, this risk will be transferred to the investors, and the Deposit Insurance Agency will have to pay for the unsuccessful bank operations.

National authorities around the world have provided citizens and businesses with support, including monetary stimulus support, in order to prevent a sharp collapse of their income. While these measures have kept citizens and businesses financially afloat for the time being, they don’t solve any problems. The global economy faces a prolonged exit from the crisis, which may be accompanied by a series of corporate and personal bankruptcies, which will negatively affect the banking business.

In Russia, banks are faced simultaneously with the problem of attracting new deposits and the growth of bad debts. From April to July, the key rate of the Bank of Russia fell from 6% to 4.25% and is unlikely to rise in the near future. Bank deposit rates also decreased accordingly. According to the Central Bank of the Russian Federation, the maximum rate on deposits in rubles in ten credit institutions that attract the largest volume of deposits from individuals decreased from 5.9% at the beginning of the year to 4.5% at the beginning of August.

In Russia, there is no need to talk about negative interest rates yet, but they are still going down, and the government is inappropriately introducing a tax on interest on deposits. All this leads to a decrease in the attractiveness of a bank deposit. In general, from the beginning of the year to August, the volume of ruble deposits increased by about a trillion, from 24.57 to 25.53 trillion rubles. But all the growth came from demand deposits, and there was an outflow of funds from deposits. Thus, funds on deposits for a period of 1 to 3 years have decreased from 8 to 7.5 trillion.

True, so far there is almost no alternative to a bank deposit. For example, you can invest in buying currency, but you also have to either take it to the bank or hide it at home, and there is a risk of fire or robbery.

At the same time, no one except banks insures money. If you invest in the stock market or in real estate, then you can both earn and lose. It all depends on the market conditions

Of course, interest rates on loans are falling, and it might be more profitable now to live in debt, but in Russia, since 2014, the real disposable income of the population has been falling (according to Rosstat, in the second quarter of this year, Russians’ disposable income fell by 8% compared to the same last year), and many people are unable to service and repay loans raised with the expectation of higher earnings that are not happening. As a result, clients are forced to refinance in order to pay off old debts and thereby fall into financial bondage. The situation becomes especially critical when clients are forced to use microfinance organization services.

This is the trend that has emerged in recent months: there has been an increase in loans and arrears on them. According to data of the Central Bank published on September 29, for the period of January to September of this year, there was a 1.4 trillion-ruble increase in loans to individuals, bringing the total up to 18.8 trillion. Of this total, Russians took out 800 billion rubles in loans between June and September. It is difficult to predict how the loans collected during this period will be serviced in the future. However, it is already known that, in general, the share of overdue loans is growing. According to the Central Bank, the share of loans issued to individuals with overdue payments of more than 90 days increased from 4.5% at the beginning of the year to 5.4% at the beginning of September. The amount of overdue loans from January 1 to September 1 increased by 29.4%: from 778.4 billion rubles to 1.7 trillion rubles. The last time bad debts exceeded the threshold of one trillion rubles was in December 2016. The National Bureau of Credit Histories reported that the share of consumer loans overdue for more than 30 days increased from 15.5% to 16.8% from January to July. In particular, the share of car loans overdue for more than 30 days increased by 1.4 percentage points up to 8.6% from January to July. However, delinquency for this type of loan reached its peak in May of this year when it reached 9.2%.

State banks in this environment feel more stable, since their funding comes largely from the state. For the rest of banking institutions, the environment presents more problems, increased risks of bankruptcy, and termination of activities. As a result, the market share of private banks may continue to decline. Our banking system is like Balzac’s shagreen skin—as the share of private organizations shrinks, it, too, shrinks.