How Negative Rates impact Trade Finance and Business Credit


The European community, Japan and now even US Treasuries (if you consider currency hedges) have moved into negative territory. The ECB started this process two years ago to encourage more lending by banks and more spending by consumers.

The verdict of whether negative rates have been a success is still out there, and according to Andrew Sheets of Morgan Stanley, there is a paradox of negative rates, “People only borrow and spend more when they are confident about the future, but by going negative, into uncharted territory, the policy actually undermines confidence.”

So what's the impact of NegRates on Trade Finance

Trade Finance predominantly uses Libor or Euribor as a benchmark rate plus capital and risk premiums added to pricing. These benchmarks are critical to price loans, financial derivatives and to measure performance.  By having the benchmark be negative, banks have effectively set the floor at “zero” so borrowers eventually do not get paid to borrow if rates sink low enough.  What a world!

If rates stay negative for long, will banks change the way they price the business and no longer use Libor or Euribor as a benchmark for cost of funds?  

This is an interesting question. Paul Coles, a Board Member of IFTA, writes, If the banks receive more deposits than they can redeploy profitably elsewhere (or have to retain some of these funds for regulatory reasons), they typically need to place the excess with a relevant central bank at the prevailing rate. If this rate is negative, the bank is effectively incurring a cost when placing these funds. In turn, these costs are sometimes then reflected in the negative deposit rates charged to clients (although it may not be always the case).

Right now, some corporates are paying to have deposits at banks:

Swiss banks to charge clients

J.P. Morgan to Start Charging Big Clients Fees

But the vast majority of us are not paying banks for deposits yet. With Central Bankers around the world handicapped by economics stuck in the mud, negative benchmark rates look to be a thing that could be with us for some time.  In addition, bank capital rules are in flux again, moving from the Advanced to the Standard approach as a way to determine risk weighted capital (more on this tomorrow).

The other interesting part of the discussion is the benchmark itself. Because of Libor pricing scandals, the supervision of these benchmarks is critical to ensure the integrity of markets.   The European Commission has put Euribor on the list of critically important benchmarks to monitor. As an aside, the other interesting observation is few people in the banking industry can tell you how Libor or Euribor is set.

So pricing trade finance should be interesting to monitor, given negative rates and the governance issues surrounding the benchmarks.

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First Voice

  1. George Papanikolopoulos:

    As far as the verdict regarding the success of negative rates, we only have to look at the last 25 odd years in Japan to recognise that negative rates wont work to fix the low/negative growth economic environment. Expansionary policies (increase spending by the 3 pillars of the economy, namely Govt, Corporate and Consumer sectors) are the only means to address the current growth dilemma. Banks will never charge negative rates to borrowers (expect if negative rates drop to an astonishingly low level), this will take us into economic inversion and banks will always be looking to make margin. We also have no real connection between central bank published reference rates and the rates at which banks borrow. Someone in a bank in Australia needs to explain how they justify a 20% interest rate on credit card (or +7% overdraft rate for business) when the central bank reference rate is circa 2% and falling, and these rates have been steady or rising even as “official rates” have been falling. LIBOR fixing is not the real scandal here

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