Mary Holm: Into the upside-down world of negative interest rates

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COMMENT:

Q: Just before the lockdown, I heard of several overseas banks going into negative interest rates on what I imagine were deposit savings accounts. This sounds like people having to pay banks to hold savings.

Given there is very little interest on most savings accounts, and possibly more money being sloshed around to stimulate the economy, it seems we are at risk of this happening. Or perhaps we only end up with 0 per cent interest. Either way, the value of a "safe" and accessible deposit gets eaten away because of inflation.

I treat my savings account as an emergency stash, money when I need it. There might be delays getting money out of even a cash fund, let alone a term investment.

If it happens here, are there practical alternatives to savings accounts that hold their value? Cash under the mattress?

A: Let's take this one step at a time. First, are we likely to see this upside down world — with people paying banks to hold their money, and banks paying people with mortgages?

"We are not planning to introduce a negative OCR rate before March next year at the earliest and only if required," says a spokesperson for the Reserve Bank.

What's more, the OCR, or official cash rate, is usually a fair bit lower than the rates banks pay customers. Right now it's 0.25 per cent. Compare that with the term deposit rates in the table above this column on the right.

The spokesperson adds: "That will be a decision for the monetary policy committee based on an economic assessment and the level of stimulus needed to achieve our mandate of low and stable inflation and support the maximum rate of employment.

"We would evaluate the use of a negative OCR against our principles and other options available."

He continues: "Negative rates refers to wholesale rates, and the retail rate will be a margin above that. International evidence shows that it is rare to see negative retail rates." Retail rates are the ones paid to or charged to individual customers.

This view is echoed by banks. ANZ chief executive Antonia Watson recently told Tamsyn Parker in the Herald, "If you look around the world there are many jurisdictions that have gone to negative interest rates, and it's very few and far between where you have seen an actual retail interest rate go negative — either us paying people to borrow money from us or people paying to put their money in the bank.

"You see that in the big end of town in the wholesale and the swap transactions, but it's been very rare to see it at the retail end."

Okay, but if we do go to negative retail rates, what are alternatives to savings accounts for emergency money?

Despite your reservations, cash funds and one-month term deposits are good options when you need money in a hurry. If you make your purchase with a credit card, by the time you have to pay the credit card bill, you will have gained access to your cash fund or deposit.

And cash funds, in particular, may pay a slightly higher return than savings accounts. Cash fund managers search for the best very low-risk investments.

On the mattress idea, I've mentioned before the threats of fire, flood, theft and hungry rats. If you're thinking along those lines, please get a decent safe.

What about tax?

Q: The Reserve Bank recently asked trading banks to prepare internal processes in the event that negative interest rates became a reality.

It seems that negative interest rates are now more than a possibility, so many will want to know how such negative rates will be treated for tax purposes. Do you know IRD's position on this?

A: I didn't, so I asked Inland Revenue the following: "If a New Zealand bank was charging negative interest on a term deposit, presumably taking the interest out of the deposited amount, would that interest 'charge' be tax-deductible — given that interest received is taxable?"

The reply is not good news for most people. "This issue is a relatively novel one that revenue authorities around the world are beginning to consider," says a spokesperson.

"On general principles in New Zealand, it is expected that interest charged on term deposits based on negative interest rates will not be tax-deductible, except where a term deposit is held by a business.

"That's because, for the expenditure to qualify for a deduction, it must be connected to income or a business."

Seems unfair to me, but I suppose we have to blame New Zealand law.

The spokesperson goes on: "Term deposits charging negative interest rates will not pass the income nexus test because there can be no expectation of income from holding investments made on those terms.

"The business nexus test would likely be satisfied where it's a term deposit investment of a business. This is the same tax treatment that would apply to related expenditure such as bank fees." Good point.

Moan — and stay put

Q: It is probably timely to seek a "lay-person's" explanation from someone of your calibre regarding negative interest rates. So here are a couple of questions:

• If someone has $100,000 on term deposit with a bank and it is to be renewed at, say, minus 0.50 per cent, does this mean the depositor will pay $500 to the bank, but not resident withholding tax because credit interest was not received?

• Could negative rates result in many depositors withdrawing their funds and lodging them in say, riskier "second-tier" funds (finance companies with C-minus ratings), shares or even buying a rental investment property partly funded by maybe a mortgage at less than 2 per cent?

• Could this lead to a run on bank funds through lack of confidence in the banking system to offer some "rate of return"?

A: On your first question, I expect the bank would just take the negative interest out of your deposit in the same way as fees and tax are taken out of many investments.

But while you couldn't deduct the interest you paid, as explained above, you certainly wouldn't have to pay tax on it. That would be preposterous!

Turning to your other two questions, if we do get negative retail rates, I suppose some people will withdraw their bank savings and invest elsewhere. But I doubt if enough people will do that to threaten banks' stability.

Consider people's options. Hopefully, the collapse of many finance companies during and after the global financial crisis a decade or so ago will be fresh enough in memories that most people won't go there — at least to the riskier ones.

Shares and rental property are possibilities, but they are considerably riskier than bank deposits. Bonds and bond funds tend to be less risky, but they can still be volatile.

And all of these are likely to be less attractive than usual in the next year or two, given our worrying economic situation.

My guess is that many people will complain about very low — or possibly negative — interest rates, but they will still save with their banks. After all, they're already used to really low interest.

- Mary Holm is a freelance journalist, a seminar presenter and a bestselling author on personal finance. She is a director of Financial Services Complaints Ltd (FSCL) and a former director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Holm's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Holm cannot answer all questions, correspond directly with readers, or give financial advice.