2. The Danger Zone – Where Nominal Yields Do Not Effectively Reimburse the Risk of Collapse

From a certain point that the markets have already achieved, banks will no longer be capable to boost credit amount to reimburse for losses from their central bank, which might clarify the disintegration of the banking sector.

The situation with negative interest rates represents the inverse structure when the borrower is subtracting what he owes by an amount calculated according to the rate arranged between the two contract sides in a sense that the more one borrows, the less will repay.

There is a certain threat behind this emergence of negative interest rates and it is being increasingly visible in Europe, since it represents the risk to its financial independence and economic expectations.

While maintaining its rate at almost zero for more than seven years, the Federal Reserve of the United States finally announced the first increase in December 2015 and since then the world markets have entered a new segment of monetary policy, the exceptional one, implemented by almost all central banks in the world after the financial crisis from the previous decade.

The question is whether this new growing progress will restrain the slow economic recovery. Financial and economic subjects become dependent on easy money and it is uncertain whether they can accommodate higher rates, so that is why all onlookers are trying to figure out what might happen by the end of the year.

There are many markets in the world, and it is especially the case in Europe, where central banks are going in the reverse trend, launching for the first time a negative interest rate policy.

Gradually declining interest rates took another aspect and have shown that it allows many countries to decrease their indebtedness in a sense that the free liquidity provided to banks is a subject of their governments. In the case of the European Central Bank the thing is only to inject money into the financial system that will be more considerate towards indebted countries and it might be perceived as a clear path.

Many national central banks, while increasing their balance sheets by buying bank debt less highly rated, flooded the financial institutions with free money, but those are in distracted seek for yields and this is the point of entering the danger zone of having investments where nominal yield does not effectively reimburse the risk of collapse.

This is actually the scheme that would never have been traded in a financial system price close to their historical average, while the cash ready to be invested since many hope that it will increase growth. However, the amount compensated is not enough to eliminate the probability of breakdown of these kinds of funds.

Besides that, this was done with the expectation that banks will offer money at lower rates for at least one whole year and since in this case the interest rate is around zero it gives some of the returns it has created after being loaned to others, who paid an interest rate to some extent higher to have an access to that money, so the bank made different type of income.

The ordinary interest rate is one that reveals the intercession among the current and the upcoming, while there is an expectation of future prosperity, so this is particularly the reason why interest rates are the highest in the poorest countries, since the loss of time is negligible. On the other side, the rate of financial interest that directly or indirectly secured the guidelines of central bankers is the price of accessible money in a specified time and therefore, whichever dissimilarity to one of these two situations is noticed, it actually represents the cause of a crisis where the money is being offered without respecting economic rules.

The situation with negative interest rates is when one gives money to the bank to deposit their capital, which, actually, becomes a price, instead of a return and during times such as these when banks put off usual savings, since keeping them does not show any sign of  gain at all. It instead becomes much more striking to borrow, because the amount one has to pay is lower than that which one loaned.

In this situation, for a trader, an additional approach to discover yields is by taking on speculative dealings and transactions related to oil, gold etc. However, the situation of having zero or negative rates has bad impact on the worth of the investment in general and endorses negative rates on savings without performance. The fact is that the risk in banking balance sheets is too high and the price of their loss will be paid by the investors, regardless how risk-averse they are.

This article is part of the academic publication Dividing by Zero by Ana Nives Radovic, Global Knowledge 2018

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