December 2014: SNB Introduces Negative Rates, a Toothless Measure?

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December 18, 2014: The Swiss National Bank has introduced negative rates above a certain threshold. Several points, however, might imply that this is a “toothless” and symbolic measure. We discuss the details on this measure.

An extract from the official statement:

The SNB imposes an interest rates of -0.25% on [CHF denominated] sight deposits, the aim of taking the three-month Libor into negative territory. It is expanding the target range for the three-month Libor to -0.75% to 0.25%…..
The threshold according to method 1a and 1b is calculated as follows:
Minimum reserve requirement of the reporting period 20 October 2014 to19 November 2014 times 20 (static component)

Negative interest will be charged as of 22 January 2015 until further notice

(detailed source)

Nomura comments: “…but the ECB’s potential QE action on 22 January could weigh on EUR/CHF. The timing of the effective date for the negative rate is the same day, 22 January, which may not be just a mere coincidence.”

Overview of sight deposits and negative interest calculation:

The measure might be only symbolic because:

• Swiss banks have enough liquidity. They do not need to interchange it at any rate, whether at 0.25% or -0.75%. The Libor lending market is dry anyway.
•  Method 1a: Local banks hold 313 billion francs at the SNB. The central bank requests a negative rate of -0.25% on sight deposits of local banks that are in excess of 20 times of the minimum reserve rate. Looking at the minimum reserves compliance available in the weekly monetary data, the measure looks only symbolic. Swiss Banks currently hold more than 2218%, i.e. 21 times, the excess reserves over the minimum reserves, hence 21 times too much.

Citi speaks of 26.8 bln. out of the total 313 bln. that are affected by negative rates.

Citi explains further:

It is clear, therefore, that the SNB has set the exemption threshold at a level which does not penalize the banks for holding high reserve levels (reserves have been inflated as the side-effect of the SNB’s large FX intervention – partly unsterilized – of recent years), but which does aim to push the interbank rate well below zero.

If the exemption threshold was set at, say, 10x minimum reserves, it would impose a high tax on bank profits, whereas an exemption threshold of 30x would fail to bite. This arrangement is reminiscent of that in Denmark, in which the negative interest rate is only applied to a limited portion of banks’ reserves.  (source Fast FT).

• The method 1b for bank-like domestic institutions – which are “not required to hold or report any minimum reserves”, is applied “in the same manner”. This sounds awkward. How can you calculate the threshold based on minimum reserves, if they are not subject to minimum reserves reporting?  It seems that minimum reserves are somehow “estimated”. Anyway, since  Swiss PostFinance is registered as a normal bank, the section of bank-like institutions is quite small.
• (Exemption for small accounts) Smaller account holders until 10 million are exempted.
• (Exemption for Swiss state authorities) “As a rule, negative interest is not charged on balances of other holders of sight deposit accounts denominated in Swiss francs (in particular the Confederation and associated enterprises as well as domestic authorities)….“
• The method 2 “for account holders not subject to the minimum reserves (foreign banks, securities dealers, cash processing facilities, clearing and settlement organisations, mortgage bank institutions, insurance companies, international oganisations, central banks” concerns
  • around 16 billion in sight deposits from foreign institutions and
  • a total of 10-20 billion from other “Method 2 counter parties” that are subject to a “fixed threshold”; details are not provided yet.

We explained that in recent weeks Swiss banks have reduced their sight deposits from 319 to 313 bln, but foreign and other deposits were up.
Reasons could be:

• Given that the value of their other collaterals weakens, Russian oligarchs are liquidating their cash on Swiss bank accounts with the consequence that sight deposits@SNB are down.
• According a research 60% of Swiss cash in circulation are 1000 CHF notes. Swiss cash in circulation has conctracted by nearly four billion in 2014. This might also be collate al-related, when business men in Emerging Markets or Russia obtain margin calls.
• Swiss banks are front-running negative SNB rates, converted the cash into higher-yielding assets – this is the typical QE behaviour. Central banks want exactly this conversion of cash into asset price inflation and the associated improving business sentiment.
• Swiss banks converted some assets/deposits held at the SNB into new loans.  This is an asset to asset transfer from the view of the bank. As opposed to  QE in the US or the UK, Swiss sight deposits are triggered by foreign inflows and not by QE mechanisms.

Be aware that many Swiss banks, similar to German ones, already introduced higher fees on accounts – in any currency. Higher fees represent a response to negative ECB rates and a preparation to SNB’s negative rates.

We are currently not fully informed how holding excess cash in a foreign currency affects Basel III ratios. But it can clearly be assumed that those assets would not be valued at 100% – as opposed to safe SNB sight deposits. In particular they cannot hold them at a central bank like the ECB that similarly introduced negative rates on its deposit facility.  Instead they must lend to European banks in the periphery with negative consequences on Basel 3 risk ratios. German banks have again enough and potentially too much liquidity: they do not need Swiss money for lending.
We know that lending in Euro zone is very weak. Economists claim that for banks in the Euro zone creditworthy borrowers are missing in a risk-reward perspective.

Hence holding excess reserves in foreign currency would weaken Basel 3 risk ratios, while holding them in CHF would lead to a “tax on profit”.

Our first opinion was that the measure was purely symbolic and targets FX traders and speculators, but not the holders of the sight deposit accounts at the SNB. Moreover, it could drive Swiss banks even more to lend for the massive Swiss real estate bubble.

The first result was to boost the Swiss market index, SMI, by nearly 2%, this is as much as the usually more volatile DAX. The EUR/CHF rose by 25 bips to 1.2040 after touching 1.2097 in early trading.

The regular readers of our blog understand that Russian oligarchs will not be afraid of 0.25% negative rates as opposed to holding cash in the collapsing Rouble. Their funds might have already been in Switzerland for a long time; they could be already invested in nice Swiss Chalets. Apart from oligarchs, other well-qualified Russians have found work in Switzerland and helped to boost Swiss GDP by 2% per year, but Russia is missing these people.

The point of view of the SNB is different

The SNB reckons that banks should not increase the monetary base and its most important component, the sight deposits, any further. Otherwise they shall be punished by negative rates. Remember that banks decide where to deposit their assets, like sight deposits. In Western countries it is not the central bank that creates money (via the money multiplier), but the commercial banks!

The situation in Switzerland is a bit different: via the euro peg, the SNB makes foreign currency purchases expensive; therefore Swiss banks might prefer to hold CHF and are not able to exchange at a more favourable FX rate.

Method 1a and 1b: Existing sight deposits are nearly all exempted from negative rates.
Method 2: Foreigners sight deposits should no longer look for the Swiss haven and remove their cash.

In the recent monetary assessment, Jean Pierre Danthine answered a journalist’s question that he would like the “real economy” to invest more but that he does not like strong growth of housing investments. Negative rates could imply that Swiss lending and “real investments” would increase. The task of the countercyclical capital buffer, however, is to tame investments in real estate. The SNB wants to sanction an increase in mortgages with additional capital requirements, but facilitate “real investments”.

 According to the Swiss SECO, investments in equipment and software rise only at a slow pace of 2.1% y/y.

Conclusion

The final conclusion is that the SNB wants more “real lending and real investments”, but less real estate investments. 

Thanks to the seigniorage effect, the SNB could be able to compensate potential losses on the FX rate. And if, thanks to improving economic sentiment, there will not be FX losses in the long-term, even better for the SNB. Highly qualified foreigners (not only Russians) might leave Switzerland one day. The SNB hedges at exactly 1.20, so that they are prepared for this remote day, the associated inflation and CHF currency depreciation. At that moment the Swiss will definitely possess far more currency reserves than countries like Russia have today. A comfortable hedge.

For reference and reactions

The IMF-compliant weekly monetary data release shows the different sight deposits.

Our overview of SNB sight deposits

Do you know where German excess reserves and Target2 claims are? Under Gerrman matresses!

One Swiss cantonal bank, the St. Gallen Kantonalbank, publicly critises the SNB: “Negative interest rates not the right option for Switzerland.” They have the same opinion as we have: negative rates could lead to further excessive lending and risk taking. Maybe the bank also fears the tax on bank profits.

Reaction: Swiss television spoke about the risks of negative interest rates for the real estate bubble

About George Dorgan

George Dorgan (penname) predicted the end of the EUR/CHF peg at the CFA Society and at many occasions on SeekingAlpha.com and on this blog. Several Swiss and international financial advisors support the site. These firms aim to deliver independent advice from the often misleading mainstream of banks and asset managers. George is FinTech entrepreneur, financial author and alternative economist. He speak seven languages fluently.

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