By Jason Douglas and Simon Clark 

LONDON -- The Bank of England asked British lenders to assess their readiness for subzero interest rates, a sign that officials are weighing the merits of a policy that bankers say would heap problems on a sector already weighed down by Covid-19 and Brexit.

In a letter to bank chiefs, the BOE said it is seeking information on banks' "operational readiness and challenges with potential implementation, particularly in terms of technology capabilities." The letter said the query wasn't a guarantee that negative interest rates would be introduced in Britain.

BOE officials had long insisted they didn't think negative rates were appropriate for the U.K. but in recent months have softened their stance as the global economy faces a slow, fitful recovery from the pandemic and the policies implemented to contain it.

"Negative rates are not a positive for U.K. banks," said Joseph Dickerson, a banking analyst at Jefferies, adding that they send deflationary signals to consumers and businesses. Negative rates hurt banks' so-called net-interest margins, or the difference between what banks pay depositors and charge for loans. "Investors would view such an event as negative for bank shares," he said.

The shift is the latest example of how the scale of the Covid-19 crisis is pushing central banks and governments deep into new policy territory. The Federal Reserve is lending to states, cities and businesses, breaking taboos about who gets money from a central bank in a crisis. European governments are subsidizing millions of furloughed workers' paychecks to minimize layoffs.

U.K. banks, including Natwest Group PLC, Barclays PLC and Lloyds Banking Group PLC, have been among the worst performers in the stock market this year, down more than many mainland European and U.S. rivals. As proxies for economic growth, the banks have suffered from the massive Covid-related economic downturn. The U.K. had the highest number of deaths in Europe and the economy has shown only tepid signs of revival.

Bob Wigley, executive chairman of UK Finance, an industry body representing more than 250 financial institutions, said he expected the BOE to consider the "implications for banks' business models and their ability to serve customers which are already impacted by Covid-19."

British banks are further preoccupied with the uncertainty about Brexit. The U.K. left the European Union in January and a temporary extension of the trading relationship between them expires at the end of the year. Negotiations over a new economic pact between the U.K. and its biggest trading partner are ongoing, but the last-minute nature of the arrangements has made it difficult for British businesses to plan.

The wisdom of subzero interest rates is still debated and evidence for their effectiveness is mixed. The Danish central bank introduced negative rates in 2012 and the European Central Bank followed in 2014. Last year, Sweden undid its negative rates despite tepid growth, figuring the distortions to the economy were too severe.

The theory of negative rates goes that by charging banks to hold deposits at the central bank, lenders will prefer to make loans to households and businesses instead. This will boost spending and economic growth. European Central Bank research has shown that negative rates boosted bank lending. But a 2019 study by former U.S. Treasury Secretary Lawrence Summers and colleagues found that by squeezing bank profits, negative policy rates in Sweden prompted banks to reduce lending rather than increase it.

Investors are split over whether or not the BOE will ever go through with introducing negative rates, citing, among other things, the risks to the U.K.'s financial sector and officials' own mixed views on the subject. U.K. government bond yields of maturities out to five years trade with a negative yield on expectations that a subzero policy rate could be in the offing.

Along with the letter to the banks, an accompanying questionnaire quizzes bank staff about issues such as which business units would be affected by negative rates and how much time they would need to make changes to their systems to accommodate them. It also asked banks similar questions about a zero policy rate and a system of paying different interest rates on slices of bank reserves.

Write to Jason Douglas at jason.douglas@wsj.com and Simon Clark at simon.clark@wsj.com

 

(END) Dow Jones Newswires

October 12, 2020 10:33 ET (14:33 GMT)

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