Term
Negative interest rate
A BudgetBurrow glossary entry. Scroll down for a plain-English definition and related concepts.
A BudgetBurrow glossary entry. Scroll down for a plain-English definition and related concepts.
A negative interest rate occurs when a lender, typically a central bank or financial institution, charges depositors to hold their money instead of paying them interest. This means the nominal interest rate falls below zero, leading to a situation where savers lose a portion of their deposits over time.
Negative interest rates emerged as a policy response to prolonged periods of low inflation, weak economic growth, and sluggish demand. By making it costly to hold money, policymakers intended to incentivize lending, investment, and consumption when traditional rate cuts became ineffective.
In practice, a central bank or financial institution sets its benchmark or deposit rates below zero. Commercial banks holding reserves at the central bank may be charged rather than rewarded, creating an incentive to lend those funds or invest elsewhere. In some cases, these costs are partially passed on to corporate or even retail depositors, making it more expensive to keep funds idle and shifting financial behavior toward spending or investment.
Negative interest rates can be applied at several levels, including central bank policy rates, commercial bank deposit rates, or even certain short-term government securities. While most commonly discussed at the central bank level, some banks implement negative rates selectively for large deposits from institutional or corporate clients, reflecting differences in exposure and risk tolerance.
Negative interest rates appear during periods of economic stagnation or deflation when standard monetary policy tools have been exhausted. Investment managers may encounter negative yields when allocating assets in developed bond markets, and corporate treasurers may need to evaluate the cost of holding significant cash balances under these conditions.
If a bank sets a deposit rate at -0.5%, depositing $100,000 for one year would result in a reduction of $500, leaving an end balance of $99,500. Instead of earning interest, the depositor pays the bank for safeguarding the funds.
Negative interest rates alter traditional saving and lending behavior, directly impacting portfolio strategies, funding costs, and capital planning. They can challenge the long-term viability of business models relying on interest income and require active adaptation from both institutions and individuals.
The presence of negative interest rates can distort risk assessment and asset valuation, prompting investors to accept lower or even negative yields on perceived safe assets. Over time, this may lead to increased risk-taking elsewhere and complicate central banks’ ability to unwind such policies without market disruption.