September 14, 2016
In a blog post earlier this week, former Fed Chair Ben Bernanke argued for a policy of negative nominal interest rates as being preferable to a higher inflation target for boosting the economy in a severe slump. While his concerns about the downsides of a higher inflation target seem somewhat overblown, there is an important negative aspect to his proposal for negative rates that his post overlooks.
If banks have to pay money on the reserves they hold, then they have less incentive to acquire deposits. This could have a large impact on their willingness to keep smaller checking and saving accounts for low- and moderate-income people. They often lose money on these accounts already, but may consider the losses worth bearing in the hope that these customers may have larger accounts in the future and/or rely on the bank for profitable services.
If interest rates on reserves turn negative, then the losses on these accounts would be even larger. This could result in banks charging for accounts that are now free and raising their fees on services for which they already charge. As a result, many low- and moderate-income people are likely to give up their bank accounts.
According to the FDIC, there were 9.6 million households without bank accounts in 2013. This number could grow substantially if banks had to start paying interest on the reserves they held.
There are potential remedies for this situation. Banks could be required to offer basic banking services at little or no cost, with other customers effectively subsidizing this service. Alternatively, we could adopt a system of postal banking which would allow low- and moderate-income households to get basic banking services through the post office.
Either of these routes would offset the risk that negative interest rates could lead to a larger unbanked population. However, without these fixes in place, the prospect of a much larger unbanked population is major downside to a policy of negative interest rates.
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