BOE Tells Banks to Get Ready for Negative Rates

The Bank of England (BOE) told banks to start getting ready for negative interest rates, while also saying that message shouldn’t be taken as a signal that the policy is imminent.

The central bank’s Prudential Regulation Authority (PRA) said most financial institutions aren’t sufficiently prepared for the prospect of negative rates, especially as regards to retail products like rate-tracking mortgages, so they should take at least six months to set their systems up without running undue risks. The BOE made the announcement as it held its key rate at a record low of 0.1 percent.

The move raises the threat that the central bank will push borrowing costs below zero, turning the lending business on its head by charging depositors to store cash while giving money back to borrowers. The BOE has been studying the case for negative rates for almost a year as a way to pull the U.K. out of its worst slump in three centuries. So far, it hasn’t followed counterparts in Europe and Japan in implementing the policy.

“I don’t think the bank would be making a statement like this if it wasn’t seriously considering using it,” said Nigel Terrington, who runs Paragon Banking Group Plc, a lender to residential landlords.

Many banks said their retail banking systems were “not built to accommodate a negative bank rate, and substantive changes would need to be made,” Sam Woods, who heads the PRA, said in a letter to financial executives that was released Thursday. He didn’t specify any banks by name.

Still, the BOE emphasized that such a radical change in policy may not occur, and that its banking-regulation arm wasn’t giving a signal about the future intentions of its monetary-policy side. That outlook lifted the pound, while money markets trimmed bets on a cut: They’re now pricing 4 basis points (bps) of easing by December, compared with 8 bps ahead of the announcement.

“The Monetary Policy Committee [MPC] stressed again that these requests, and any subsequent related supervisory actions determined by the Prudential Regulation Authority, should not be interpreted as a signal that the setting of a negative bank rate or a tiered system of reserve remuneration [was] imminent, or indeed in prospect at any time,” the BOE said.

The issue was a real concern for members of the MPC. The committee was divided on whether to ask banks to start the work, with some members believing the economy wasn’t troubled enough to contemplate the policy and worried that the request to banks could be misconstrued, according to the minutes of the latest meeting.

“My message to markets is: You really should not try to read the future behavior of the MPC from the actions we’re taking on our toolbox,” Governor Andrew Bailey said in a webcast after the report.

The European Central Bank (ECB) became the first major monetary authority to cut interest rates below zero in June 2014, a year after the Eurozone exited a double-dip recession, when the ECB was worried that a too-strong exchange rate was depressing inflation.

Its deposit rate has continued to be reduced since, and is now at a record-low -0.5 percent. It wasn’t cut during the pandemic, in part because of concerns that the pain it inflicts on banks undermines its effectiveness.

The BOE also said that, should it end up cutting below zero, it will start its own work on a tiered rate system. Both the ECB and the Swiss National Bank have tiering systems that exempt some lenders’ deposits from negative rates—an effective tax on their reserves that they struggle to pass onto customers.

It’s helpful that the BOE is specifying the six-month preparation time, said John Garvey, global financial services leader at PwC. He compared it to the investment rush more than 20 years ago to make sure the millennium wouldn’t disrupt date-based information technology.

“It is a bit of a ‘Y2K’ moment,” Garvey said. “There are an enormous number of models, systems, and contracts that will need to be addressed.”

—With assistance from James Hirai, Lucy Meakin and Harry Wilson.

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