By Tommy Stubbington And Margot Patrick
Bank stocks led an intensifying rout in financial markets, amid
concerns that global central banks struggling to boost growth will
worsen an already tough environment for lenders.
The Dow Jones Industrial Average closed down 254 points on
Thursday, and U.S. oil prices fell near $26 a barrel, in a broad
flight from risk that sent haven assets climbing. Gold gained 4.5%
to its highest level in a year. Bond prices rose, sending the yield
on the 10-year U.S. Treasury note, which tends to decline when
investors get nervous, to its lowest level since May 2013.
The pressure reflected concerns that investors have wrestled
with for months, including falling commodity prices, a slowdown in
China and heavy debt loads in emerging markets. What is new is that
investors are now worrying that banks are being caught in the
middle as central banks in Europe and Japan turn to negative
interest rates to spur growth.
Those policies, which charge lenders for reserves they keep on
deposit with central banks, are crimping lenders' profits and
amplifying fears of a wide economic slowdown. At the heart of the
concerns is an alarming conundrum: While hobbled banks may not be
able to tolerate rates this low, limping economies may not be able
to tolerate them any higher.
The "doom loop" that sent eurozone banks and countries into a
spiral of mutual deterioration four years ago could now be
encircling central banks and lenders.
"The markets see this club of central bankers barreling down
this path, which is really experimental for a number of reasons and
doesn't seem well thought out in terms of the impact it could
have," said Scott Mather, chief investment officer U.S. core
strategies at Pacific Investment Management Co., or Pimco.
Bank shares plunged on both sides of the Atlantic, with Bank of
America Corp. down 6.8% and Credit Suisse Group AG falling 8.4%.
The KBW Nasdaq Bank Index of large U.S. lenders fell 4.2%.
For battered banks in Europe and beyond, negative rates come at
the worst possible time. Regulations implemented after the
financial crisis are making banks simpler and more resilient, but
revenue streams have been cut off, and stock, bond and commodity
trading is less profitable. Large fines at many banks for past
misdeeds have held back capital building.
Now, subzero rates are threatening their most traditional source
of income: the difference between what a bank earns from lending
and the amount it pays for deposits. Instituting a negative deposit
rate drags down other interest rates in the wider economy, making
borrowing cheaper.
Investors said the recent rate moves into negative territory by
central banks in Europe and Japan are an important ingredient in
the cocktail of fears hammering bank stocks around the world. At
the heart of concerns that European banks could stop paying
interest, or coupons, on their riskiest debt, or will need to raise
new equity, is a sectorwide decline in profitability that shows no
signs of easing.
Economists at J.P. Morgan Chase & Co. warned this week that
banks might respond to negative rates by hoarding cash and cutting
lending, although that hasn't been the case yet in countries with
negative rates, including Switzerland, Denmark and those in the
eurozone.
The European Central Bank cut rates further into negative
territory in December, while the Bank of Japan introduced a
negative rate last month. Some smaller nations have gone further,
with Sweden's central bank lowering its main interest rate to
minus-0.5% on Thursday.
Meanwhile, on Thursday, Federal Reserve Chairwoman Janet Yellen
said the U.S. central bank is studying the feasibility of pushing
short-term interest rates into negative territory should it need to
give the economy a stronger boost.
In a way, the move below zero was a gamble. The theory went like
this: Banks would take a hit, but negative rates would get the
economy moving. A stronger economy would, in turn, help the banks
recover.
It appears that wager isn't working.
The consequences are deeply worrying. Weak banks may now drag
the economy down further. And with the economy weak and
deflation--a damaging spiral of falling wages and prices--looming,
central banks that have gone negative will be loath to turn around
and raise rates.
Moreover, central banks have few other levers to escape that
doom loop. The ECB has instituted a bond-buying program, but
President Mario Draghi last month indicated he was ready to launch
additional monetary stimulus in March. Japan's decision to
implement negative rates follows three years of aggressive monetary
easing, aimed at ending two decades of low inflation and stagnant
growth.
The pushes into negative territory also amount to a sort of
competitive currency war that no one seems willing to call off.
Major economies around the world are desperate to spur
inflation; one way to do that is to cut interest rates, which
typically would make their currencies less attractive. Lower
currencies raise the prices of imported goods and boost the
fortunes of exporters.
Switzerland, Sweden and Denmark have all used negative rates to
help ward off inflows of foreign funds that push up their
currencies. Economists said an aim of the Bank of Japan's move to
negative rates last month was to weaken the yen. It hasn't worked:
The yen shot up Thursday and is stronger than it was before the
rate cut.
The move below zero compounds the miseries for lenders in those
countries. Banks traditionally make a profit by lending at higher
interest rates than the rates they pay on deposits, a difference
called the net interest margin. Low rates have already squeezed
that margin, and banks' funding costs from other sources, such as
bond markets, have surged this year.
German banks earn roughly 75% of their income from the margin
between rates on savings accounts and the loans they make,
according to statistics from the Bundesbank, the country's central
bank. Plunging rates dragged German banks' interest revenue down to
EUR204 billion ($230 billion) in 2014 from EUR419 billion in 2007,
according to the Bundesbank.
Negative rates cost Danish banks more than 1 billion kroner
($151 million) last year, according to a lobbying group for
Denmark's banking sector.
The impact is showing up in lackluster bank earnings. Shares in
Italy's UBI Banca SpA tumbled 12% Thursday after it reported net
interest income below expectations. Bank analysts said further
surprises to investors' expectations on bank margins are possible.
U.K. banks HSBC Holdings PLC and Standard Chartered PLC are poised
to benefit from higher U.S. rates, but further rises by the Federal
Reserve are looking less likely.
For now, one factor working in banks' favor is that negative
rates touch only a small piece of their balance sheets. Even for
the cash they do have at central banks, a host of rules exempts
portions of those reserves from the negative-rate penalty. So far,
just 2.2% of banks' assets in the eurozone are subject to negative
rates imposed by the ECB, according to Alex Dryden, a global market
strategist at J.P. Morgan Asset Management. In Japan, the figure is
just 0.9%.
"Negative interest rates on a benchmark basis are not the final
frontier. Only when negative rates begin to impact consumers and
the real economy will we be entering a topsy-turvy world," Mr.
Dryden said.
More deeply negative rates would force banks to make a choice:
Either suffer an even greater hit to their margins or risk scaring
off customers by passing on negative rates to them. Either outcome
would mean more pain for the banking sector.
Philippe Bodereau, global head of financial research at Pimco,
said he doesn't expect that to happen in the eurozone, because the
ECB will be wary of sparking a crisis in the banking sector that
spreads to the real economy.
"We would be very surprised if the ECB went into a deeply
negative interest rate as this would raise concerns over financial
stability," he said.
Christopher Whittall and Madeleine Nissen contributed to this
article.
Write to Tommy Stubbington at tommy.stubbington@wsj.com and
Margot Patrick at margot.patrick@wsj.com
(END) Dow Jones Newswires
February 11, 2016 19:44 ET (00:44 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.