How should co-operative banks deal with the negative rates dilemma?

A small German co-operative bank, Raiffeisenbank Gmund, has introduced a negative interest rate on deposits. Well, not all deposits. Just large ones. Very large ones, in fact.

The little bank, in picturesque Tegernsee in the Bavarian Alps, attracts deposits from film stars and sportspeople. It has imposed what it calls a “custody charge” of 0.4% on demand deposits over €100,000.

This represents a radical departure from the business model for co-op banks. Germany’s small banks have always resisted passing on the European Central Bank’s (ECB) negative rate to their savers. Now one has broken that convention, others may follow.

This is driven by survival. Banks earn their income from the spread between the interest rates they pay on deposits and the interest rates they charge on lending. The rates Germany’s little banks can charge for lending have been falling for some time now, eroding their income.

Maintaining positive interest rates for savers in the face of what is becoming a severe margin squeeze is getting harder. Either interest rates to savers have to fall, or some of these banks will go out of business.

Part of the problem is the ECB’s negative rates policy. Banks have to keep a certain amount of money in reserve to meet demand for deposit withdrawals (payments). This money is held on deposit at the ECB. But if banks keep more on deposit at the ECB than is strictly needed, they are charged a negative rate similar to Raiffeisen Gmund’s “custody charge”. This is supposed to encourage them to increase lending.

Even in tranquil Tegernsee, low interest rates are causing trouble Image:
Even in tranquil Tegernsee, low interest rates are causing trouble (Image:

For Raiffeisen Gmund, which has a substantial excess of deposits over loans and struggles to increase its lending in the tiny Bavarian town, this negative rate amounts to a tax. Substituting safe assets such as German government bonds doesn’t help, because the ECB is buying such large quantities of these in its quantitative easing (QE) programme that their yields have fallen below zero, effectively meaning that these too cost money to hold. It is hard for a bank awash with deposits to avoid the negative rate.

Unsurprisingly, banks blame the ECB’s easy money policies for their plight. A spokesperson from the German co-operative banking association has said: “The ECB’s extreme monetary policy is creating considerable costs for all banks.”

But the ECB’s policies are far from the whole story. The deepest problems facing Germany’s co-operative banks lie much closer to home.

A new age dawns for mutual insurance

The first is the behaviour of German savers. Many Germans prefer to keep their savings in banks, regarding stocks and bonds as unsafe. Figures from the Deutsche Bundesbank show that savings in banks make up 40% of all German household savings.

Cash savings have been increasing steadily over the last two decades, while investments in stocks and bonds have fallen. And even cash savings are changing: savers are choosing more liquid demand deposits – “currency and transferable deposits” – over accounts which force them to tie up their savings. People want to be able to get at their money whenever they want – but this makes it difficult for banks to predict their funding needs.

On the other side of the balance sheet, banks are suffering a lending squeeze. Germans are not big on borrowing at the best of times. Their culture is one of saving and thrift, rather than borrowing and spending. Even their language discourages borrowing: in German, debt – “schuld” – means “guilt”. And since the 2008 financial crisis, borrowing has declined, and saving has increased.

Now, there are too many savers wanting positive returns, and not enough borrowers willing to provide them. Consequently, interest rates are falling. They would be falling even without the ECB’s negative rate policy and QE.

In addition to the changing behaviour of customers, co-operative banks face fierce competition from private sector banks and non-bank providers. This puts further pressure on their margins, as savers demand higher interest rates, and borrowers want lower ones.

There has already been significant consolidation in the co-operative banking sector, and it seems likely that there will be much more to come. Imposing negative rates on large deposits is thus a defensive strategy. Perhaps, if the bank can maintain a slightly wider interest rate spread, it can stave off bankruptcy or takeover.

But is applying negative rates to deposits, even large ones, consistent with co-operative values? Savers might argue that quite a few co-operative values are not being observed when negative rates are imposed on them. Are they right?

Germany’s small banks have always resisted passing on the European Central Bank's negative rate to their savers
Germany’s small banks have always resisted passing on the European Central Bank’s negative rate to their savers

The co-operative values that particularly appear to be violated by negative rates on large deposits are equality, equity (“fairness”), and democracy.

First, let’s consider Equity. To many savers, imposing negative rates seems unfair. The banking model has not changed. In the popular mind, banks still use savers’ money to fund risky lending, particularly (for German co-operative banks) lending to small and medium-size enterprises. Savers have always been paid for allowing their money to be put at risk in this way. But now, some savers are to be charged for providing banks with funding for risky lending.

The deposits on which the negative rate will be charged are also uninsured, since €100,000 is the EU’s deposit insurance limit. So, although Raiffeisen Gmund calls the negative rate a “custody charge”, it is not in fact offering safe custody. If the bank fails, the excess of the deposit over €100,000 could be lost.  

So far, this has never happened in the German co-operative banking network – but the possibility is there. This looks like a pretty raw deal for people with large amounts of money in the bank.

But against that we have to put the fact that savers, as much as borrowers, are owners of the enterprise. If the bank goes bust because its margins are eroded so far that it does not make enough money to pay its overheads, everyone loses. Arguably, it is not fair to employees and borrowers to resist negative rates, if they are necessary to keep the co-operative afloat.

"Co-operation can mean putting the needs of the whole community above narrow self-interest"
“Co-operation can mean putting the needs of the whole community above narrow self-interest”

And that brings us to Democracy. There is nothing democratic about any of the forces bearing down on co-operative banks. But how they deal with those forces is a matter for their membership to decide.

The question is whether the management, in deciding to impose negative rates in order to protect the income of the co-operative as a whole, is acting in accordance with the democratic wishes of the members. Did the management of the German co-operative bank that imposed negative rates consult its members?

Of course, a decision NOT to impose negative rates could be equally undemocratic. We can’t assume that just because a small set of rich members is losing out, the decision was undemocratic. Democracy, by its nature, can mean that some people don’t get what they want, and co-operation can mean putting the needs of the whole community above narrow self-interest.

And finally, equality. At first glance, it appears that large depositors are not being treated equally. They face erosion of their capital and possible losses, while smaller savers are protected.

However, they do not face these losses on their entire holding, only on the amount in excess of the deposit insurance limit. So in fact they do have the same protections as smaller savers.

Another accusation is that they are being treated unequally compared to borrowers. ECB monetary policy does indeed aim to benefit borrowers at the expense of savers. But the purpose is to benefit the whole of society, by encouraging investment and spending.

In the end, the question for co-operative banks is this. Which is more important – the narrow need to treat savers and borrowers equally, or the wider social need to generate recovery and growth that benefits all – the co-operative value of solidarity?