U.S. interest rates never lifted very far from postcrisis levels before recession fears set in and the Federal Reserve reversed course, embarking on cuts officials have called a mid-cycle adjustment.
With little room to maneuver above zero, and with powerful global forces tugging equilibrium rates down, some banks have been nervously eyeing counterparts in Europe and Japan that have been forced to operate in negative-rate environments. Companies including JPMorgan Chase & Co., PNC Financial Services Group Inc. and Regions Financial Corp. have described internal deliberations over the scenario, the viability of strategies to hedge against circumstances that currently seem remote, and the possibility of massive changes in business models.
Analysts who have tried to model the impact of negative rates on U.S. banks paint a grim but not necessarily terminal picture.
European and Japanese banks are surviving
In Europe and Japan, negative rates are a sign of profound economic fragility and have been a feature of long periods of malaise. Nevertheless, below-zero yields are mostly the province of central bank policy instruments and government bonds, and banks continue to make money from lending.
Kroll Bond Rating Agency argued in a note that negative rates "as currently exist in Europe and Japan have nothing to do with economic calamity," observing that employment is relatively strong in Europe, and that unemployment in Japan is even lower than in the U.S.
In a note, analysts at Keefe Bruyette & Woods used Japan as a point of reference and said they "would expect spreads to narrow but remain positive" in the U.S. if negative rates materialize here. The analysts also said that U.S. banks might have a structural advantage because they could off-load low-yield, long-term assets into large securitization markets.
The bad news is that the examples provided by Japan and Europe are bleak. Analysts at Baird Equity Research said in a note that spread income at Japanese banks has fallen about 25% over the last two decades.
KBRA expects that net interest income would get squeezed in the U.S. in a negative rate scenario as asset yields flatten against funding costs that banks would have limited ability to drive below zero, but said that the impact would "not represent a material threat to the creditworthiness" of the industry.
Negative rates would be "just a continuation of the challenges" that banks already face, Ethan Heisler, a senior director at KBRA, said in an interview. "The real issue is that low interest rates are a bank killer."
Models suggest negative rates would clobber bank returns
The regulatory stress test scenario in 2016 incorporated negative rates, and the KBW analysts combined pre-provision net revenue from those exercises with actual loan loss expenses that year to get an idea of how bank earnings might be impacted in the absence of a recession. The median drop in EPS for the eight U.S. global systemically important banks was 25%. "We would classify the results as negative but not catastrophic," KBW said.
The KBW analysts also simulated the effect of a prolonged period of low rates and slow growth on a hypothetical bank, and estimated a cumulative drop in earnings of almost 30% over a four-year period.
Negative rates could provide offsets for banks, including by boosting the value of portfolio assets and lowering credit costs by making it easier for borrowers to service debt and access loans. A recent Bank for International Settlements paper on unconventional monetary policy tools said that because of factors like these, "side effects" from negative rates including compressed bank net interest margins "have not posed a major problem for banking stability to date."
Small banks could get hit the hardest
But the credit boost might disproportionately help big banks with large consumer portfolios, KBW argued, and large banks would also be relatively insulated from depressed net interest income by robust fee-generating businesses.
Further, while data KBW compiled on non-U.S. deposits at State Street Corp. and Bank of New York Mellon Corp. shows that banks can pass on negative rates to wholesale customers, small banks would likely have less leeway with retail accounts. The BIS report noted that it is not feasible for large companies and other organizations to meet their treasury management needs with cash.
"This hurts regional and community banks more than it hurts large banks," Heisler said. "The problem is, banks can't really price deposits below zero. They can price wholesale deposits below zero, but" regional and community banks primarily have retail deposits.
"Just an inverted yield curve is bad for banks, so I think negative rates would be really bad," Peter Winter, an analyst at Wedbush Securities, said in an interview. "There's no bank that is positioned for negative rates."
Fed officials squeamish about negative rates
Long-run interest rates may be out of central banks' control, but Fed officials have expressed qualms about pushing their policy rate below zero even during times of severe economic distress.
After the Fed's rate-setting meeting in September, Chairman Jerome Powell said the central bank evaluated negative rates as a policy tool during the financial crisis, but opted for quantitative easing and guidance that it would keep rates low for a long time. Powell said the Fed would likely turn to those options again in similar circumstances. At an appearance in September, Boston Fed President Eric Rosengren said that negative rates could inhibit lending by hurting bank profits, and create a signal about policymakers' outlook for the economy that would weaken public confidence.
Still, high savings rates, low productivity growth, and strong demand for safe and liquid assets are pushing down interest rates across the globe. In the U.S., they have dipped ominously in recent months, with the real 10-year rate falling to -0.09% in late August, according to the yield on Treasury Inflation-Protected Securities.
"In a low-rate environment globally with growth slowing, negative rates will remain a risk for U.S. banks," KBW said.