Falling interest rates, including some that have turned negative, have pushed custodians to charge for cash balances in Danish Krone and Swiss Francs. While one custodian has been charging a fee for a couple of months now, the information went public in an excellent Bloomberg article published today, “Depositors Fleeing Euro Get Negative Rates at State Street.” The article says that State Street is now charging 75 bps for large amounts of cash held in Danish Krone, and 25 bps for larger cash deposits in Swiss Francs. This is an important move on the custodians’ parts and may has ramifications for other parts of the financial services industry that readers should consider.
According to the Bloomberg article, “State Street will apply a negative interest rate of 0.75 percent annually to krone deposits starting Nov. 1, with a separate charge for francs, according to a note to clients last week. That means money managers, insurance companies and pension funds must pay the bank to hold their cash. BNY Mellon started charging for krone deposits last month, a person with knowledge of the matter said. The lender isn’t charging for francs…. Denmark and Switzerland have cut interest rates close to or below zero to keep the krone and franc from rising as investors flee the euro for safer havens, reflecting concern that the currency may break up. While negative rates may drive off some customers, global lenders want to restore the profit margin between what they pay for deposits and what they earn on investments.”
Seen from the custodians’ point of view, this is a legitimate move. The other options are lousy, including losing money due to a negative spread on earnings less expenses and client income. Another non-starter option is to engage in credit transformation trades (see our article last week on the LSE losing revenue on the Italian money market vs. Italian repo) for accounts have no regulatory restrictions (money market funds need not apply). Most clients probably wouldn’t like the Italian repo or the FX risk and no custodian wants to be called out for engaging in Shadow Banking-style activities. We doubt that any of the custodians’ clients can blame them for going negative; after all, if the Danish government has a target interest rate of -0.02%, how on earth is a cash manager expected to pay a positive return on cash balances?
The Krone and Franc case is relatively small; the deposits affected have to pass a certain threshold and are only for institutional investors. However, we draw attention to the precedent this could set for all investors worldwide. Already the Federal Funds rate has been in the 15 bp range with frequent lows of 5 and 6 bps. The daily Gilt repo overnight rate was 46 bps last week, much higher than the Fed Funds rate but still low by historical standards. If things were to get a bit worse globally as projected by today’s IMF global economic forecast, larger economies could see negative real interest rates too.
If custodians were to expand the practice of charging for cash deposits, broker/dealers and banks would almost certainly follow suit. So would any insurance company or money market fund that has been dealing with the difficulties of earning an investment return in a hyper-low interest rate environment. The expiration of FDIC’s Transaction Account Guarantee (TAG) program will put $1.4 trillion of currently insured deposits outside of the FDIC insurance scheme and, depending on where the cash goes, may be additional incentive for big banks to go negative for small depositors. We wrote about this in a SFM post on October 3rd. Most readers are aware of the negative rates BNY Mellon introduced last year for large deposits in dollars. This gets hairy, and as an August 2012 Fed blog article recently pointed out, can lead to strange unintended consequences like putting actual cash in vaults and getting cashiers checks to stash in a drawer.
We will be paying close attention to the actions of custodian in charging for cash deposits; we see them as a precursor of wider financial movements to come.