LUXEMBOURG
ALEXEY YEREMENKO

Why do some banks adopt negative rates?

The story of negative rates started in 2008 when the financial crisis created a lingering economic slump that pushed the ECB (European Central Bank) to experiment with lending rates and cut them eventually below zero in 2014. Facing the renewed signs of economic weakness, the ECB continued to push down the interest rate and in September 2019, we have a situation where banks have to pay -0.5% on the funds parked with Central Banks. Therefore, depending upon the structure of balance sheet, some banks are simply forced to pass negative rates to customers. As a result, customers are somehow «punished» by keeping their money in the bank.

“Customers are somehow ‘punished’ by keeping their money in the bank”, Alexey Yeremenko, East-West United Bank, Head of Investments and Trading - Lëtzebuerger Journal
“Customers are somehow ‘punished’ by keeping their money in the bank”, Alexey Yeremenko, East-West United Bank, Head of Investments and Trading

What are the outcomes for the customers?

Customers will get negative nominal return and real return will be even more negative since even «official» or narrowly defined inflation is positive. According to ECB projections «official» inflation will be around 1,4% in the next few years. Therefore, in reality clients would be losing much more than just a negative rate on a deposit or current account. It is nothing but a financial repression, where savers are forced to pay an extra tax on their savings. Practically, customers would see reducing balances on their current accounts. In a case of term deposit, they get back an amount, which is lower than the original deposited amount. As a result, their purchasing power will be destroyed.

Investments in fixed instruments (bonds) which typically used as a substitution of bank deposits might also disappoint investors in the first half of 2020. Currently, roughly 25% of investable fixed income universe trades at negative nominal yield, which is a result of ultra-loose monetary policy by Central Banks, trade wars rhetoric and weak economic data we observed during the summer.

A 10% increase in oil prices leads to 0,4% increase in inflation

What are the options for customers who would like to protect their wealth in a negative nominal and real interest rate environment?

Portfolio investments is one of the alternatives, although a traditional 50% - 50% allocation between equities and fixed income most likely would not deliver a desired result. Besides negative nominal and real return on a fixed income part of a portfolio, the other headwind for an expected return of the portfolio is lower benefits of diversification from fixed income part of the portfolio. If correlation between performance of equity and fixed income is positive and relatively high, then traditional portfolios become more risky. An investor should not forget that before Asian crisis in 1997 a correlation between equities and bonds was positive and as a result investors’ portfolios were more volatile. Historically, we saw a positive correlation between equities and bonds during the periods of relatively high inflation and stagflation. That might well be the case going forward: US core inflation is at the highest level since 2008 with oil prices at 50-60 dollars per barrel instead of 130 dollars per barrel we had back in 2008! According to a recent IMF study a 10% increase in oil prices leads to 0,4% increase in inflation. Therefore, even a relatively modest, by historical standards, increase in oil prices may lead to a significant uptick in inflation. That means that sell off in bonds and equities would happen at the same time and lead to more significant portfolio losses. That’s quite different from investors have seen for the last twenty years when fixed income part of portfolio play a role of natural hedge for an equity part of the portfolio at the time of crisis.

In East-West United Bank we offer thematic Discretionary Portfolio Management, which aims to deliver a premium on top of inflation rate by employing global trends in portfolio construction. With our thematic approach we aim to identify long-term structural trends and invest in companies we believe will take advantage of these trends. As an example, through our innovation theme, we are currently invested in robotics, medical technology, fintech and digital innovations.

Another alternative is online savings platforms that, thanks to their business model, offer positive interest rates for saving accounts and term deposits; customers can open accounts without visiting the bank and usually, savings up to certain amount are protected by the government deposit guarantee schemes. In Luxembourg East-West Direkt provides such a service. It could be a good option for those who would like to protect their euro savings in the current environment.

EWUB

Private and corporate banking

East-West United Bank (EWUB) was founded in Luxembourg in 1974. EWUB provides private and corporate banking services. In 2019 EWUB became one of the few banks in Luxembourg to offer trade finance products to its customers.
Today, 98 bank employees from 29 countries serve private and corporate clients, including: individuals with assets over 1 million euros; companies engaged in international trade or business; holdings, securitization and investment companies.
The Bank also serves over 3.000 customers from Luxembourg and Germany through its East West Direkt online platform launched in 2017.