Negative interest rates: borrowers’ paradise

Laura Oliva Financial risk management guide, Interest rates

The interest rate with a maturity of one month for Euro zone (called 1Month Euribor) has officially dropped below zero for the first time on January 19, 2015. It’s a turning point, it had never happened before that the official interest rates, the same ones that are used as a reference for the cost of mortgages and loans showed negative values.

It’s an extraordinary time: lenders must pay to lend. Eurozone banks have a liquidity glut that fail to invest. So as not to keep cash in hand are willing to invest with negative interest rates.

1 Month Euribor

1 Month Euribor



This happens mainly because of two contributing factors: monetary policy and deflation.
European expansionary monetary policy has been intensified since June of last year when ECB imposed for the first time negative deposit rates for banks. In an effort to stimulate investment liquidity and therefore the funding of banks to the economy, the ECB wanted to discourage possible parking of cash in deposits by financial institutions.

Despite all the efforts of the monetary policy, today in the Euro zone remains the risk of deflation. Deflation is a threat to the economy mainly because it reduces the value of real investment (such as real estate).

1.1 The Swiss case

Interest rates in Switzerland have been negative for several months, even for long-term maturity: up to 9 years. What does it mean? The negative rates are a disincentive to deposit Swiss Franc. Swiss institutions try to limit the accumulation of bank deposits in order to reduce the strength of the currency and to stimulate the financing of the economy.

The Swiss National Bank has accelerated the policy of negative rates following the decision to abandon the “cap” on the exchange rate of the franc against the Euro. Even yields on government bonds with a maturity of two years are below zero in Germany, Finland, Austria, France, Netherlands and Belgium.

Let’s say that there are people paying some governments for the privilege of lending them money.

CHF interest rates

CHF interest rates


1.2 Why a negative interest?

Why are there investments in negative rates securities? Because there are investors not interested in collecting coupons and interests. Interested to invest where there are opportunities to maintain and to preserve the capital. It’s a unique situation in the history of the modern economy. Investing in corporate bonds and in the debts of those countries that have a high rating because hoping in capital gains. The negative interest paid is considered as a sort of “fee”, a necessary cost that allows access to a world of privileged investments.


One of the most effective tools for understanding the interest rates scenario is the “Yield curve”.
The Yield curve is closely watched by many traders, CFO, portfolio managers, financial analysts. At a glance, it is a snapshot of debt conditions, it embeds a lot of valuable information about the economic situation, it is capable to capture early signals of financial distress.

2.1 What is the yield curve?

The yield curve shows the yields or interest rates across different maturity (e.g. 1 month, 3 month, 6 month, 1 year, 2 year, 3 year, 5 year, 10 year, and so on…) for some financial instruments.

For example, the interest rates paid by the Italian Government on debt (BOT, CTZ and BTP) for various maturities are plotted on a graph, displaying the relation between the level of interest rate (basically, the cost of borrowing for the Italian Government) and the time to maturity (the “term”) of the bonds.

There is a different yield curve (often called the “term structure of interest rates”) for each currency and rating level, as borrowing conditions vary according to currencies and credit quality, and even from instruments to instruments.

So, there is no single yield curve describing the cost of money for every market participant, as each market segment has its curve.

Usually, long-term yields tend to be higher than short term yields.

The reason is that the further you look into the future, the greater the uncertainly about the level of inflation, and the greater are the chances that the borrower will not pay-back interests and capital.

That is, uncertainty about inflation and redemption probability create uncertainty about a bond’s real return risk. This makes a long term bond a riskier investment than a shorter one. And that is the main reason why yield curves usually are upward sloping.

Hence, the term structure of interest rates reflects expectations of market participants about future inflation, and their assessment of monetary and credit conditions.

In order to understand this, you may think that each nominal interest rate of the yield curve can be decomposed as follow:

Nominal rate =
real rate + expected inflation rate premium + credit premium

Yield curve ITA Greece

Yield curve Italy and Greece


2.2 The curve shape

Based on this simple decomposition one can interpret the various shapes of the term structure that can be observed on the market place.

There are three main shapes:

  • normal – the slo-pe of the yieldcurve is positive;
  • steep – the slope of the yield curve is strongly positive, with short rates much lower than long terminterest rates;
  • inverted – the slope of the yield curve is negative.

2.3 The main features

There are two main features to monitor.

A. The overall level: it signals about the monetary and economic conditions; with gloomy economic conditions and loose monetary policies the overall level of the term structure of interest rates is generally low.

B. The slope: is one of the most powerful predictors of future inflation, economic growth, or recessions, and market distress.

In particular, if you think about the simple nominal rate decom- position above, it is clear the an abrupt rise of the credit risk premium or the inflation premium can impact in a savage way on the shape of the term structure.

Think about the Greece government curve (Figure 3) in from January 2015 up to now: the curve is inverted, with the short rates reflecting growing default probability in the short run. An inverted yield curve can signals an economic decline: all the US recessions since 1970 up to now have been preceded by an inverted yield curve.


Seven years of recession have brought the gift of paradise to debtors: interest rates to levels below zero. Never seen better conditions for borrowing.
The cost of financing has reached historic lows, also spreads are decreasing. If you have offered investments financed by debt, this is the right time. If you plan to fix the rate of interest with a floating rate swap, this is the right time.

Who can, take advantage of it!


Authors: Laura Oliva & Raffaele Zenti

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