What is a negative interest rate?
When interest rates go below zero, you lose money.
Normally, when you take out a loan, you pay your bank or lender interest on top of the amount you borrowed. Negative interest rates work the opposite way — the bank or lender pays you to borrow money from them. But why would financial institutions do this, and do such loans exist in Canada?
Why do negative interest rates exist?
Since the Global Financial Crisis (GFC) the world’s understanding of finance has changed rapidly. One idea that has emerged from the GFC is implementing negative interest rates. Negative interest rates are incentives for banks. The bank holds reserves and these are taxed by the negative interest rate, so the bank has higher incentives to lend out its reserves.
A few countries have stopped using zero interest rate policies (ZIRP) and have adopted negative interest rate policies (NIRP) instead. Switzerland was one of the first countries to implement NIRP in the 1970s in an attempt to deter a flood of foreign investment.
Following the 2008 recession, Sweden was the first country to begin implementing a negative interest rate, while the European Central Bank (ECB) adopted such a policy in 2014. As of July 2019, Japan, Sweden, Denmark and Switzerland are all offering negative interest rate loans.
So how does this affect me?
Right now, it probably doesn’t. While commercial banks get to decide what interest rates to offer customers, those rates are usually based on the prime rate set by the Bank of Canada. While interest rates have dropped significantly over the past several decades, at the time of writing, Canada has never used negative interest rates.
However, some economists think that conditions are ripe for Canada to jump on board with the growing global trend. With housing prices pushing higher than ever, lowering the national interest rate could end up being the only way to prevent the housing bubble from bursting and sending real estate values spiraling downward.
After all, lower interest rates mean that more of your mortgage payment can go towards paying off the principal of your loan – and not interest – which means that you can afford to pay for a higher-priced home.
Pushing interest rates into negative territory can induce more spending and borrowing, thereby stimulating the economy. Implementing a negative interest rate is an attempt to inject more liquidity — more cash — back into markets so people can afford to spend more and the economy can avoid sharp deflation.
Canada’s financial stability
The Canadian banking system continues to benefit from strong overall asset performance. Rising home prices have forced more mortgage lending, which is particularly significant for banking stability. Interest rates in the country have also risen slightly as the economy has started to recover from the Global Financial Crisis. However, if they dip back down in the future, the Bank of Canada could decide to implement a negative interest rate. If they did, it would be up to your bank to decide whether or not to charge its own negative interest rates.
A negative interest rate could be a way to stimulate the economy, but so far it isn’t something we’ve tried out in Canada. Economists are divided over whether or not it would be a good idea — it would encourage spending and inject cash into the market, but it would also make it more difficult for people to save. That being said, even if the federal funds rate dips below zero in the future, there’s no guarantee that banks would pass that savings on to you.
Looking for more information about interest rates? Check out these helpful articles below:
- Car loan interest rates
- Credit card interest rates
- Best* high-interest savings accounts
- Compare fixed rate vs. variable rate personal loans
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