A successful experiment by the Danish banking sector to charge negative interest rates on a growing number of retail depositors is likely to draw interest from financial institutions across Europe as they, too, seek tools to withstand the intensifying pressure from a prolonged low-rate environment and record inflows of deposits.
While negative rates on personal accounts are not unheard of in Europe, Danish banks have moved "extremely fast" over the past 12 to 18 months to expand the scope of customers covered by such charges, said Nicholas Rohde, owner of BankResearch, a provider of analysis on financial institutions in Denmark. "If it can be done in Denmark, then it can also be done elsewhere," he said.
In August 2019, Jyske Bank A/S was the first in Denmark
For business customers, banks have gone further, imposing negative rates on every penny deposited. Some have even introduced a margin on the interest charged as compared with the central bank rate of minus 0.5%. Danske, for one, charges businesses a negative rate of up to 1.00%, while this rate is negative 1.25% at Nordea.
Danish banks' "more aggressive" approach is likely down to the fact that Denmark has had a negative central bank rate for longer, said Sydbank equity analyst Mikkel Emil Jensen.
When Danmarks Nationalbank first introduced a deposit rate below zero in 2012, lenders resisted passing the bill on to their customers, but years of downward pressure on net interest margins have changed that. The challenge intensified as the coronavirus pandemic prompted low credit demand and record deposit inflows.
As of March 2021, Danish banks had a deposit surplus of more than 617 billion kroner, which they have to place with the central bank or in capital markets.
Banks across Europe are "in the same boat," with Denmark being "just a little further ahead," said Jensen, calling the Danish model a "proof of concept." Unless central bank rates rise significantly, he believes European lenders are likely to follow in the Scandinavian country's footsteps.
Here are some of the most important lessons from Denmark.
A tool to relieve earnings pressure rather than boost profits
In 2020, Danish banks for the first time earned more from charging retail and business depositors negative rates than the banks paid in interest to central banks and other credit institutions, according to a recent analysis by BankResearch. While in 2012, Danish lenders had a total interest expense on deposits of 13.8 billion kroner, this turned into a gross income of close to 1 billion kroner in 2020. BankResearch expects this figure to increase to 3.5 billion kroner in 2021.
Yet, a Finance Denmark analysis, which focused on consumer accounts, found that banks are still making a loss on their deposit business in isolation, given that most of the surplus deposits are placed at negative rates in the capital markets and thus not covered by BankResearch's analysis. Furthermore, Finance Denmark found that, even with an exemption limit of 100,000 kroner, three in four workers are still unaffected by negative interest charges.
READ MORE: Up to 50% of Danish retail deposits hit by negative rates, with more to come
Danske Bank has estimated that its latest two rounds of negative rates initiatives would add about 1 billion kroner in net interest income annually, all else being equal, which according to Jensen's forecast corresponds to a net profit boost of about 7% in 2022, a majority of which will come from business customers. This is a good "proxy" for the rest of the banking sector, he said.
However, Jensen said most of the income boost will be "eaten up by other challenges," such as pressure on lending margins and low credit demand. Negative rates on customer deposits should be seen more as a tool to withstand an otherwise downward pressure on earnings rather than a way for banks to make profits, he said.
Customers generally accept negative rates
Banks in Denmark have faced "some turbulence" in the media every time they have lowered the exemption limit, said Jensen.
Even the Danish business minister, Simon Kollerup, has joined the debate, saying on April 27 that banks should "stop now," while calling it "greedy" when lenders charge negative rates while delivering large profits.
But once such debates have settled, customers have generally accepted the lower thresholds as the "new normal," Jensen said. "In general, we hear that there is predominantly good understanding from customers."
For Danske, the negative rates initiatives so far have not prompted any significant customer outflows, and "on the contrary, we've actually seen an increase in deposits," said CEO Carsten Egeriis April 18 during an analyst call.
The resistance to negative rates from business customers has been limited as they often have a better understanding of the drivers for such moves, said Rohde. This has enabled banks to implement more far-reaching initiatives for businesses than retail customers.
Herd behavior may prompt more moves
While Danish banks have come far in their negative rates moves, there is no indication they have reached the limit just yet. Rohde said the threshold for when banks impose negative interest on retail depositors is "trending towards zero," meaning that Danish consumers may soon be charged on all of their deposits.
Within a "small number of years," if the current low-rate conditions and earnings pressure continue, Rohde also expects that the vast majority of institutions will charge a margin on deposits as compared with the central bank's rate. If the central bank charges a negative 0.5%, banks may impose a negative 0.6% or 0.7% interest on personal customers, he said.
Jensen agreed that lowering the exemption limit to zero may be the "ultimate consequence," but expects the current 100,000 kroner threshold to stand longer than previous limits. Introducing a margin on the interest charged could also become relevant, especially if the central bank were to increase its rate, said Jensen, in which case lenders can passively bring in a margin by keeping their customer rates at the same level.
The herd effect will be an important determinant for what comes next, with the Danish proof of concept having so far shown that once one bank makes a move, whether for business or retail customers, bank peers are likely to follow. That is in part because they are facing the same earnings pressures, but also because rate initiatives at one bank can give rise to a costly "flood of deposits" at others, said Jensen.
As of May 18, US$1 was equivalent to 6.09 Danish kroner.