Current issues related to economics, (sustainable) investment, pensions and income: every week an APG expert gives a clear answer to the question of the week. This time: macroeconomist and expert strategist Charles Kalshoven, on the effects of a government-mandated minimum savings interest rate for banks.
Over the span of just under a year, the European Central Bank (ECB) raised policy rates in increments from -0.5 percent to 3.25 percent. Unlike with mortgage rates, however, this ECB increase did not cause savings interest rates to rise in the same way - to the frustration of consumers and politicians. It led to a threat from Belgian Prime Minister Alexander De Croo: “We have a free market, but if it doesn’t work, we have no choice but to intervene.” In that case, the legal minimum savings rate of 0.11 percent in force in Belgium would be raised further. How desirable or undesirable is such an intervention by the government?
Cartel
In principle, a government should only intervene when a market is not functioning, says Kalshoven. For example, if there is market abuse by a monopolist or a price cartel.
“A monopoly or cartel leads to artificially high prices. That goes against the public interest, making government intervention necessary. The question is whether to do that through the introduction of a maximum price or - in this case - a minimum interest rate. After all, unfettered price setting has a function: it guides the decisions made by producers and consumers. With a higher price, suppliers will, in principle, produce more, while more consumers will reconsider whether a certain product or service is still worth that price to them. If you tamper with that mechanism by setting a minimum or maximum price, this control mechanism becomes less effective, making supply and demand less compatible.”
To protect consumers, the government would therefore do better to turn to other instruments that leave the functioning of the price mechanism intact.
“Suppose bakers get carried away and start abusing their monopoly position by making their bread exorbitantly expensive. Then, as a government, the best thing to do first is to see what you can do to improve market efficiency. Perhaps there are obstacles to new bakers that you can remove. Just the threat of competition can lead to price moderation. Similarly, higher savings interest rates should really come from the market. If there are too few banks to choose from, a government could take a look at the so-called entry barriers.”
Mass withdrawals
Kalshoven is not under the impression that there is anything wrong with the market functioning of the Dutch banking sector. After all, consumers can withdraw their savings relatively easily and transfer them to another bank.
“For savers who find the current interest rates of the major Dutch banks of around 1 percent too low, there are alternatives. Quite a few new banks have joined over the years that offer significantly higher savings rates, currently up to 2.3 percent. If enough customers switch to such a competitor, at some point banks are bound to raise their savings rates as well. A savings account at a new bank can be opened in minutes, and the collapse of Silicon Valley Bank did highlight how quickly bank customers can move their savings these days. Of course, how much urgency there is for a bank to increase its savings rate does depend on its needs: how much money does it want to attract and how much credit does it want to provide?”
In addition to opening a savings account with a competing bank, consumers can also opt to invest the withdrawn money at low risk, such as in short-term German government bonds. Kalshoven: “Then you may get an interest rate of around 3 percent, which is close to the current ECB rate. Of course, you have to take into account that investments involve transaction costs and are taxed differently than a savings account.”
Making money
The fact that after the ECB raised the policy rate mortgage rates started to rise faster than savings rates makes sense, Kalshoven argues. After all, to make a profit, the bank must attract money at a lower rate than the rate at which it lends it.
“Roughly speaking, a bank attracts savings and extends business loans and mortgages. Consumers have a long-term fixed interest rate on their mortgages, especially in recent years. Therefore, out of a bank’s total mortgage portfolio, there is only a small portion each year with variable interest rates - the newly closed mortgages. But if a bank changes the savings rate, it has to do so for all its savings accounts at once. That has an immediate financial impact, while a change in mortgage rates has a delayed effect. Ultimately, a bank still has to make money with its interest rate business. So it is not surprising that after an increase in the ECB interest rate, savings rates may rise a little less than mortgage rates.”
Kalshoven therefore agrees with the Belgian central bank, which spoke out against raising the minimum savings rate. “If you force banks to raise savings interest rates, you can also disrupt lending. Because what do you do as a government when banks respond to a forced increase by raising the price of credit? Then you have to invent a new measure for that too. Then politicians will increasingly sit in the bank manager’s chair. It is good that there is legislation to prevent excesses - and regulators who monitor them. But within these frameworks, it is really wiser to leave business decisions to the companies - in this case banks.”
Champion borrowers
So, a government-imposed minimum savings interest rate is not a good idea on the whole? “Right, because there are enough choices for consumers to ensure a well-functioning market. In the Netherlands, savings interest rates have also risen quite a bit. It is true that in the Netherlands, many people save through pension funds, while Belgians accumulate much more through their savings accounts and home ownership. The Dutch, on the other hand, are champions of borrowing, with their high mortgages. Perhaps that is why they are more likely to complain about mortgage interest rates than the Belgians, for whom it seems to be the other way around.”