Bank of England asks lenders if they are ready for negative interest rates as part of plan to boost economy

Banks should provide details on how they would cope if interest rates were cut to zero or even turned negative, the Bank of England has said.

Deputy governor Sam Woods has written to financial institutions across the UK saying they must be operationally ready for such a move, which has not been ruled out.

Negative interest rates were considered by the central bank during a meeting in September, although Mr Woods was keen to stress no decision had been made.

The idea of negative interest rates, which have been used in other countries for several years, is to encourage banks to increase lending because the Bank of England will charge them to hold their cash.

Britain's Deputy Governor for Prudential Regulation and Chief Executive Officer of the Prudential Regulation Authority Sam Woods has written to financial institutions across the UK

Countries with existing negative and zero per cent interest rates 

Denmark, Switzerland, Sweden, Japan, and many countries within the European Union, already have negative or zero per cent interest rates. 

The Bank of Japan went negative in 2016, mostly to prevent a strengthening yen from hurting its export-heavy economy.

The Swiss National Bank’s negative interest rates were introduced five years ago, at -0.75 per cent.

Most countries in the European Union, currently have a zero per cent interest rate, the UK has a rate of 0.1 per cent. 

The central bank of Sweden has a benchmark rate of zero per cent.

In other countries there have been cases of below-zero mortgage rates, including a home loan charging minus 0.5 per cent in Denmark.

The Danish bank does not actually pay borrowers a cheque in interest payments every month, it knocks the amount off the debt. On a £100,000 mortgage, for example, the debt would fall by £500 in the first year even with no repayments.

Families and household savers are unlikely to have to pay to have their money in a savings account, but any interest rate offered would be expected to fall.

Variable-rate mortgages could fall but many have clauses saying interest payments will never fall below zero.

In the letter to firms, the banker wrote: 'We recognise that a negative policy rate could have wider implications for your firm's business and your customers.

'The Bank and PRA (Prudential Regulation Authority) will consider the wider business implications, including on financial stability, safety and soundness of authorised firms and pass-through to the wider economy.

'This letter, however, is seeking information to understand firms' operational readiness and challenges with potential implementation, particularly in terms of technology capabilities.'

He added: 'As part of this work, we are requesting specific information about your firm's current readiness to deal with a zero Bank Rate, a negative Bank Rate, or a tiered system of reserves remuneration – and the steps that you would need to take to prepare for the implementation of these.'

The questionnaire asks firms of their readiness for rates of zero, a tiered approach used in other countries and interest rates with large decimal places – citing an example of a Base Rate of 0.00001 per cent.

Mr Woods was also keen to stress in the letter that the fact he was asking for details is 'not indicative that the MPC (Monetary Policy Committee) will employ a zero or negative policy rate… This engagement is not asking firms to begin taking steps to ensure they are operationally ready to implement a negative Bank Rate'.

Banks and financial institutions have been asked to respond with answers on costs, technology requirements and details of potential consequences by November 12.

Pedestrians sit on benches in view of the Bank of England in the City of London, September 2020

How do negative central bank rates work and what could it mean for your savings and mortgage? 

Banks make millions of pounds in profit from the margin between the amount they charge borrowers and pay savers interest. 

The Bank of England makes an average of £75million each year from 'activities other than printing banknotes', according to its website.

But if the Bank of England's base interest rate turns from a positive percentage to a negative, this could result in a saver being charged to keep their money in their bank account - while the borrower pays less for a loan. 

Negative interest rates basically mean a bank pays a borrower to take money from them, so they pay back less than they are loaned. 

The aim is to encourage banks to give out money in the form of loans so it is charged less for keeping money at the Bank of England. 

At the moment a person who takes out a loan has to pay the bank money on top of the original loan. The saver, meanwhile, is paid by the bank to keep their money in its account. 

The borrower pays interest while the saver is paid interest. The 'interest rate' is something Money Saving Expert Martin Lewis has described to BBC Radio 5 Live as 'the cost of money'.

As banks are asked to provide details on how they would adapt to negative interest rates, what could the change mean for your money? 

WHAT WILL HAPPEN TO MY MORTGAGE?

If the mortgage is fixed-rate nothing will happen if interest rates head into the negative.

But if it is a variable-rate mortgage, a tracker or a mortgage linked to a lender's standard variable rate it could fall if the base rate is cut unless terms and conditions prevent it.

Others may have a minimum rate the interest can hit before it's stopped. For example, Nationwide has a cap at zero per cent. For some of its mortgages Santander makes it clear the lowest rate it will charge is 0.0001 per cent.

Miles Robinson, head of mortgages at online mortgage broker Trussle, told the Independent: 'In the 2008 financial crisis, people who had tracker rate mortgages pegged below the base rate found lenders reducing their rates to 0 per cent on occasion, but not into the negative because of the floor, as well as terms and conditions in place.'

I'M LOOKING AT TAKING OUT A MORTGAGE - WILL IT BE FREE?

Mr Lewis said mortgage holders wouldn't have any cost for borrowing money, which 'would help some'.

Negative interest rates mean the sum a mortgage holder owes falls each month by more than however much has been repaid.

In Denmark last year borrowers with Jyske Bank were lent money at a rate of -0.5 per cent.

Roneish Myers, a finance coach for MoneyHeave, told MailOnline: 'It’s possible, yet unlikely, that variable mortgages will become free. 

'Even though, this has been seen in other countries within Europe. It’s likely that the government will put some new terms into place to avoid this from happening, as it's not sustainable. 

'With that being said, there is likely to be an increase in tracker mortgages and a decrease in companies offering variable mortgages.

'With fixed mortgages we are currently seeing that rates are falling.' 

WHAT ABOUT MY SAVINGS?

Andrew Hagger, the founder of the financial information website Moneycomms, told The Guardian he doesn't think banks will start charging people to hold savings in a bank account.

'Many would just withdraw cash and possibly keep it in the house, thus opening a can of worms around security and break-ins,' he said. 

'However, if the Bank of England did introduce negative rates, I’m sure we would see even more savings accounts heading towards zero.' 

Wealthy savers could be the first to be charged for deposits. UBS' ultra-rich clients were first charged a fee for savings of more than €500,000 (£449,000) last year. 

It started at 0.6 per cent a year and rose to 0.75 per cent for larger deposits. The Danish Jyske Bank has a similar policy.

Mr Lewis said: 'If we go into negative interest rate territory, you will get no interest and you need to start paying a fee. 

'Ultimately you'd say "why don't I start keeping the money under the mattress?"

'Well, the answer would be that £85,000 per person per financial institution FSCS protection that you get from putting money in a savings account.'