The end of negative Swiss interest rates is imminent. For the first time in years, there are signs of movement in savings interest rates which could be highly unpleasant for many a bank, as an analysis by finews.com shows.
«A run would be a great thing, of course!» said Markus Schwab to finews.com last August. At the time, the CEO of banking app Yuh had just launched savings rates of 0.5 percent, anticipating the end of negative interest rates in Switzerland and the prospect of rising savings rates.
This morning, the Swiss National Bank (SNB) is expected to set the key interest rate back to zero after the central bank foreshadowed a 0.5 percentage point rate hike from -0.75 percent to -0.25 percent last June.
This would end the era of punitive interest rates in Switzerland after the SNB first imposed negative rates at the end of 2014. By all expectations, a historic event is on the horizon.
Stubbornly at Zero
Many rates important to the financial fabric here are already found in positive territory. For example, Swiss franc swap rates are currently trading between 1.5 percent and 2 percent; medium-term notes are yielding more than 1 percent in some cases, and negative interest rates have never been charged on mortgages.
In contrast, interest rates on deposits by small savers have remained stubbornly at zero for the past seven years. Now it is becoming apparent that this area, which is vital for the refinancing of banks, is also on the move - and probably faster and more comprehensively than the banks would like.
Mobility is Underestimated
Andreas Ita and Claude Moser, partners at the Zurich-based consulting firm Orbit36 and both with illustrious careers in capital management and treasury at UBS warn against this. Hardly anyone knows the pitfalls of maturity transformation and the inner workings of bank balance sheets as well as the two experts; their firm now has major banks from all over the world knocking on its door. «The pricing of savings deposits and deposit accounts is a challenge in the current environment,» Ita tells finews.com.
He and Moser both believe that Swiss banks are underestimating the mobility of savings and could be forced to pay savers a higher interest rate within weeks rather than months - with consequences for interest margins. Those who do not participate in the «battle for deposits» could even have problems with refinancing.
This indicates that hectic times lie ahead, especially for the bank managers and boards of directors of the domestic banks, which have been accustomed to success up to now. The following six upheavals in the interest business could cause them problems.
1. The hour of the New Banks
Yuh boss Schwab hopes to win up to 200,000 new customers with his savings interest campaign. That sounds like an illusory number, considering the proverbial inertia of local bank customers. But Moser and Ita warn that past experience with the «stickiness» of savers could be deceptive.
After all, they say, digitization makes it possible to set up a new account and initiate e-banking within minutes to transfer funds from the previous bank to the new provider. «With mortgages, customers have long been advised to go shopping,» Moser points out. «This can also be done well with savings and deposit accounts.»
With the expected SNB interest rate hike, banks, as well as neobanks and fintechs, will be able to invest even short-term funds at positive interest rates again. This makes it easier for the new players to put enticing offers in the shop window, especially since they do not have to refinance long-term committed loans on their balance sheets.
2. The Crux at the Long End
The established banks, on the other hand, face the dilemma that a large part of their assets (e.g. mortgages) are locked in for the long term at low interest rates. While on the liability side of the bank balance sheet, according to Orbit36, around 95 percent of customer deposits are subject to repricing, on the asset side the figure is only 30 percent. This mismatch has been accentuated in recent years because mortgage borrowers wanted to «lock in» low interest rates for as long as possible, while longer-term time deposits hardly seemed attractive in the low interest rate environment.
As a result, higher interest rates on savings deposits must lead to a decline in net interest income.
3. Hidden Interest Rate Risk the Fore
Interest rate risks reported in standard interest rate risk and funding reports are based on simplified model assumptions that underestimate the effective interest rate risk on the liability side of the balance sheet in the current environment, say Orbit36 experts.
They further expect competition for customer deposits to trigger shifts in product volumes; meanwhile, most interest rate risk, funding risk, and liquidity risk models assume a static balance sheet assumption. Put simply, this means that the models assume that product volumes remain unchanged despite changes in interest rates.
This is not without risk. Bank boards of directors that rely on traditional models may not be aware that their institution is at much higher risk in the event of a rise in policy rates than is apparent from the reports available to them. Also, are now much more exposed to the risk of rising interest rates. For example, according to Orbit36, the share of demand deposits that can be withdrawn from savers overnight, as it were, has increased from 15 percent in 1996 to 55 percent in 2020.
4. Insurance of Interest Rate Risks is Expensive
Banks could have insured against the risk of a rise in interest rates, but this has been costly in the negative interest rate environment. They, therefore, had a strong incentive either to deliberately not fully hedge interest rate risk or to increase the duration assumption on the liability side so that fewer swap transactions were required. These assumptions may now turn out to be too optimistic on the liability side.
5. Possibility of Cross-Subsidization Dwindles
If the SNB abolishes negative interest rates this Thursday, the exemption that banks enjoyed with the SNB will also become obsolete. Up to a certain amount, financial institutions were thus allowed to deposit funds with the SNB at zero instead of the penalty interest rate of -0.75 percent. This concession turned into a good deal in the negative interest rate era, as the institutions were able to make their unused allowance available to other banks, for example. Orbit36 estimates the economic value of the exemption limit at CHF 4 billion annually.
Negative interest rates were widely charged to customers for larger customer deposits, while new sources of income were created with fee increases for the general public.
This alimentation of the margin is now also coming under pressure. As reported by finews.com, the price supervisor of the Swiss Confederation has taken a close look at fee inflation in banking. It is urging banks to reduce fees as soon as the interest rate situation normalizes.
6. False Confidence
Since, from the banks' point of view, customer deposits are the cheaper alternative to borrowing on the interbank or capital markets, savings deposits are likely to be in even greater demand. This could take its toll on those banks that have persuaded their customers to withdraw their funds by charging negative interest rates or have tried their customers' patience by being too hesitant to pass on positive interest rates.
Conclusion: Banks that, out of consideration for their net interest income and relying on strong customer loyalty, hold on to very low interest rates on savings and deposit accounts for too long could be confronted with outflows of funds that are difficult or expensive to refinance from other sources. This could be done, for example, by issuing long-term bonds or Pfandbrief bonds.
However, the possibilities for securitization of mortgages, for example, are considered too underdeveloped in Switzerland to be a real alternative in bank refinancing.
The experts at Orbit36 regard the mass withdrawal of savings and liquidity problems, i.e. the classic «bank run,» as an extreme scenario with low probability. Nevertheless, they recall that in the U.S. in 2017, one major bank immediately paid better savings rates in response to the Fed's interest rate hike - and the other players followed suit within just three days. Similar effects were also seen in the U.S. market in the wake of this year's rate hikes, he said.
«Orbit36 expects that there could be a negative surprise in terms of net interest income for some domestically oriented banks in 2023,» Ita concludes.
