AFR Article 13 July 2021. Page 16

The prudential regulator wants banks to be prepared for zero and negative interest rates, and has called on them to take all ‘‘reasonable steps’’ to ensure their technology systems can deal with extreme monetary policy settings.

The Australian Prudential Regulation Authority said yesterday that it had written to the banks seven months ago, asking them if they would have any problems in implementing negative interest rates.

The Reserve Bank has said many times that a negative cash rate would be highly unlikely in Australia. Such a setting could support economic activity, by keeping downward pressure on borrowing rates and exchange rates. But negative rates could also make it harder for banks to lend and encourage saving over spending.

The banks’ responses showed they were typically well-placed to deal with negative market interest rates on products managed by their treasury operations, APRA said.

But some banks pointed to the operational challenges if negative rates were applied to lending and deposit products (which means they would have to pay customers to park funds with them). Other banks flagged the costs of fixing the existing systems to deal with negative rates.

APRA said that at the very minimum, banks should ‘‘develop tactical solutions’’ – short-term fixes to create workarounds on existing systems – to implement zero and negative market interest rates and the cash rate by April 30, 2022. It wants this done for all products referencing the cash rate or a market interest rate. This includes business lending, residential mortgages, personal loans and credit cards.

The regulator said it would finalise its expectations by October 31 and wanted feedback by August 20.

Its focus on a potential negative interest rate world comes as financial markets consider that the Reserve Bank might lift official rates faster than expected, despite its governor, Philip Lowe, insisting that they will not rise before 2024.

The regulator acknowledged the RBA’s position that a negative cash rate is unlikely. Dr Lowe said in December it was ‘‘extraordinarily unlikely’’ the central bank would adopt such a position, which would involve ‘‘clear costs’’ including on the supply of credit by making it harder for banks to lend.

But APRA said it still wanted banks to be prepared, because ‘‘it is possible that other interest rates determined in the financial markets could fall to zero or below zero at any time’’.

Negative interest rates have been implemented in Europe, Japan, Sweden, Switzerland and Denmark.

The Reserve Bank of New Zealand has also asked Australian banks to be prepared for a negative policy rate: it sent a communication similar to APRA’s December letter in May last year.

APRA said there were risks if banks were not prepared for zero and negative interest rates, and these were material enough to trigger its Prudential Standard CPS 220 on risk management.

It wants banks to ensure they have controls to address operational risk in a negative rate world, and to consider the potential for conflicts of interest and the fair treatment of customers.

Banking analysts say negative interest rates would harm earnings.

In an analysis of the prospect of negative rates published last year, Macquarie said banks would ‘‘be able to navigate the negative rate environment through repricing measures’’, but ‘‘earnings headwinds will be difficult to offset in full’’. Banks with a higher proportion of deposit funding would be hit harder as they would lose their funding cost advantage, Macquarie added.