More Than 80% of Financial Institutions Not Prepared For Negative Interest Rates

Eighty-four percent of financial institutions would not be prepared to operate immediately in a negative U.S. interest rate environment, according to a recent survey conducted by the Risk Management Association (RMA).

"Negative rates in the U.S. are unlikely for now, but definitely not impossible at some point," said Nancy Foster, President and CEO of RMA, a not-for-profit, member-driven professional organization whose sole purpose is to advance the use of sound risk-management principles in the financial services industry. "Now is the time for banks to think the unthinkable and get ready for something that has already happened in other major economies. RMA and its councils stand ready to support our members in planning for a day when the unthinkable becomes the inevitable."

For the survey published in its white paper, Focus on the Negatives: Banks' Assessment of the Potential for a Negative U.S. Rates Policy - And Their Preparedness, RMA polled 47 financial institutions, ranging from global to regional, and found that many currently lack the technical capacity to accommodate negative rates.

Its survey also revealed that 75% of respondents would be ready within one year and that many agree with the widely held assumption that the U.S. Federal Reserve would give advance warning of a negative rates policy, although estimates of the length of that warning period vary.

A strength for many firms is the inclusion of negative rates scenarios in their modeling: Sixty percent of respondents to RMA's survey say their software and systems are able to handle negative rates across five classes of models and scenarios.

RMA recommends that financial institutions take immediate action to prepare for negative rates, such as conducting a formal readiness assessment, ensuring that third-party vendors are prepared, and establishing a remediation plan, where needed.

A "not trivial" possibility

While the white paper recognizes that a negative rates policy in the U.S. is considered unlikely, it recommends that financial institutions prepare for the "not trivial" possibility.

The paper lists six key reasons why negative rates could become a reality:

* The Federal Reserve's statements do not rule out negative rates always and everywhere.

* Europe and Japan have blazed the trail, serving to desensitize managers to the psychological barrier that crossing the zero floor might present.

* For the largest of firms, the Comprehensive Capital Analysis and Review (CCAR) stress-testing scenarios already incorporate negative rates and underscore their possibility as real.

* Current legal and operational impediments are not considered permanent but could be resolved by will, time, effort and restructuring in the markets.

* Fed Fund futures already trade episodically at negative implied rates.

* Some serious monetary policy thinkers see reasons why negative rates might be superior to quantitative easing over the long run, especially with respect to potential political interference in credit allocation.

The paper also discusses reasons why a negative rates policy remains unlikely, the unintended consequences a negative rates policy could have, and the historical context of negative rates.

The survey was conducted from June through July 2020 in collaboration with RMA's Global Markets Risk Council.

The white paper, including the survey, can be downloaded here: https://www.rmahq.org/focus-on-the-negative-banks-assessment-of-the-potential-for-the-us-negative-rates-policy-and-their-preparedness/