Speculation that New Zealand may use negative interest rates to reflate its COVID-19 punctured economy could weigh on ASX bank stocks.
The Reserve Bank of New Zealand (RBNZ) asked the big four ASX banks, which dominate the country's banking sector, to be technically and legally ready to handle a negative cash rate by the end of the year, reported the Australian Financial Review.
Our central bankers have repeatedly voiced their distain for using negative rates to stimulate the Australian economy. But it's understood that the banking regulator APRA have spoken to the banks on whether their IT systems can support such a dramatic move.
Negative rates and ASX banks
So, what are negative rates and how will that impact on ASX banks? Well, negative rates are when Authorised Deposit-taking Institutions (ADIs) are charged interest for keeping money with the central bank.
It's the reverse of what we are used to and it's like Commonwealth Bank of Australia (ASX: CBA) charging customers for keeping money in their savings account.
Having said that, don't expect the banks to pay you to take out a mortgage. That will never happen, sadly.
How negative rates can impact the economy
The thinking behind the strategy is to force banks to lend out as much as they can instead of sitting on cash. The more readily cheap loans are available, the more it should stimulate the economy.
This sounds like a great plan, so why won't the Reserve Bank of Australia (RBA) get behind this? The fact is, a negative rate is not a silver bullet and may even have unintended consequences.
Why the RBA is loath to use negative rates
For one, this policy could force banks to issue more risky loans, which isn't what the RBA wants. Banks being forced up the risk curve could destabilise the financial system.
Further, it's not so much supply but demand for credit that's the bigger issue. Rates are already at record low thanks to the RBA holding the three-year government bond yield at 0.25%.
However, consumers and businesses will be reluctant to borrow as joblessness gets worse or remains elevated for a few years.
Profit impact on ASX banks
More importantly to ASX investors is how negative rates can impact on profits of banks like CBA, Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB).
Make no mistake, the big banks will likely feel the pressure from negative rates across the Tasman, and its ANZ Bank that is most exposed.
Some experts warn that negative rates will decimate bank earnings by putting net interest margins (NIMs) under even more strain.
NIMs is the difference between what banks borrow money at and how much interest they can charge from lending the cash out. As banks are very unlikely to charge customers for putting money into their savings accounts, it means their profit margin will shrink with negative interest rates.
Foolish takeaway
But this isn't a given. The European experience doesn't always support this hypothesis as NIMs are impacted by a range of factors, not just official interest rates.
For this reason, it will be interesting to see how negative rates in New Zealand will flow through to our big bank earnings when they next give an update.
Watch this space fellow Fools!
