Andréa M Maechler: How negative interest works and changes in the
management of foreign exchange reserves
Speech by Ms Andréa M Maechler, Member of the Governing Board of the Swiss National
Bank, at the Media News Conference of the Swiss National Bank, Berne, 10 December 2015.
* * *
Accompanying charts can be found at the end of the speech.
In my remarks today, I will begin by talking about developments on financial markets since the
middle of the year. Then I will discuss the way in which negative interest works. I will conclude
with a report on changes in the way we manage our currency reserves.
Situation on the financial markets
I will start with the situation on the financial markets. Financial market developments since the
middle of the year have mainly been shaped by three topics: the uncertainty surrounding the
first interest rate move by the Federal Reserve, monetary policy easing measures by the
European Central Bank (ECB) and concerns about growth prospects in the emerging
economies, particularly China. In mid-August, disappointing economic data and an unexpected
depreciation of the renminbi against the US dollar resulted in a sharp decline in the Chinese
stock market. The fallout was also felt by stock markets of other emerging and advanced
economies in short succession. After volatility on the stock markets had increased sharply at
times, investors' appetite for risk gradually returned at the end of September.
Favourable economic data from the US and the euro area contributed to the more positive
sentiment. In addition, concerns about growth in China recently slipped into the background
again. The stock markets of the advanced economies, which have since been able to partially
recoup their losses, were the main beneficiaries of this recovery. By contrast, in the emerging
economies, the wave of selling has had a lasting impact. In the most recent period, the MSCI
Emerging Markets Index - calculated in local currency - was still approximately 12% below its
level at the end of June.
Stronger signals of diverging monetary policy stances between the euro area and the US were
also reflected on the foreign exchange markets. On the one hand, the prospect of higher
interest rates in the US boosted the US dollar. On the other, it put the currencies of emerging
economies under pressure. Since mid-year, the US dollar has appreciated by 4.5% on a
tradeweighted basis. The euro initially gained ground at times as a result of uncertainty in the
emerging economies. However, after the ECB had held out the prospect of further monetary
policy easing measures, the single currency came under downward pressure. By the beginning
of December, the expectations of financial market participants had not been fulfilled and the
euro gained in value again. By comparison with its mid-year level, the euro has appreciated
only marginally on a trade-weighted basis.
Demand for secure investments remained high worldwide. On the bond markets, yields on
longer-term government bonds declined further. Chart 1 shows that the decline in yields in the
euro area was somewhat greater than in the US. The yields on ten-year German government
bonds have fallen by almost 20 basis points since the end of June. In France and Italy, the
decline in yields was more pronounced. Meanwhile, yields on ten-year US treasury bonds have
changed relatively little.
On the Swiss capital market, almost the entire yield curve has shifted downwards again since
mid-year. Yields on Confederation bonds with terms of up to 13 years are currently in negative
territory. This corresponds to three-quarters of the outstanding volume. At the beginning of
December, the yield on ten-year Confederation bonds reached a new low of
-0.4%. Most recently, it was trading at -0.25% or about 40 basis points lower than mid-year.
How negative interest works
In the second part of my remarks today, I will talk about the way in which negative interest
works. Since January, the Swiss National Bank (SNB) has been charging negative interest of
-0.75% on sight deposits held by banks and other financial market participants at the SNB.
Negative interest is a key instrument in our monetary policy. Together with our willingness to
intervene on the foreign exchange market, it counteracts the overvaluation of the Swiss franc.
When calculating negative interest, the SNB grants the banks exemptions so that the banking
system does not have to carry the full burden resulting from the high level of sight deposits.
For banks subject to minimum reserve requirements, the exemption threshold is calculated as
20 times the minimum reserve requirement, based on a reference period. For sight deposit
account holders not subject to any minimum reserve requirements, the exemption threshold
has been set at a minimum of CHF 10 million.
By applying negative interest universally to all account holders, we are adhering to the principle
of equal treatment. It therefore makes sense that banks with above-average sight deposits in
proportion to their minimum reserves pay higher interest than other banks. In this respect,
negative interest is no different to traditional monetary policy measures. Although the
conditions are always the same for all participants, the precise impact may differ for individual
banks or market participants and depends on their balance sheet situation.
The full effect of negative interest is felt on the money and capital markets even in the case of
high exemption thresholds. At present, at approximately CHF 170 billion, some 40% of SNB
sight deposits are subject to negative interest. Nevertheless, transmission of the negative
interest rate is working well, with interest rates on this market aligning themselves directly with
the negative interest rate of -0.75%. This is because interest rate determination is based on
the marginal interest rate, in other words the rate for holding one additional unit of sight
deposits.
Movements in SNB sight deposits
Chart 2 shows sight deposits of domestic banks (dark blue area) which, together with other
sight deposits (light blue area), comprise total sight deposits at the SNB. Cumulative exemption
thresholds come to some CHF 300 billion. When negative interest came into effect in January,
thresholds were 88% exhausted. Since then, this percentage has steadily increased and is
now just over 98%.
There are two principle reasons for this. First, a redistribution of sight deposits between banks
has taken place. Institutions whose sight deposits exceeded the exemption threshold have
transferred money from their SNB accounts to banks which had not exhausted their threshold
and were prepared to accept these funds at somewhat less negative interest than -0.75%.
This redistribution of sight deposits can be observed, for instance, on the Swiss franc repo
market. Chart 3 shows how, on that market, turnover was considerably higher than that
recorded for the whole of 2014. Most of the turnover was accounted for by transactions with
very short terms. This is likely to include many transactions aimed at exhausting remaining
thresholds.
The second reason for the higher exhaustion of the exemption thresholds is that banks' sight
deposits at the SNB have increased overall. Since negative interest came into effect in
January, sight deposits have risen from approximately CHF 440 billion to some CHF 470 billion
at present. The interest burden increases overall when the SNB feeds more liquidity into the
system, in particular in the event of further foreign exchange market interventions. This, in its
turn, makes it even less attractive to hold Swiss francs. Now that almost all exemption
thresholds are exhausted, every newly-created Swiss franc is subject to negative interest.
Changes in the management of foreign exchange reserves
I now come to my third and final topic. Two important new developments have occurred in the
SNB's investment activities this year. The SNB has enlarged its investment universe, moving
into both Chinese government bonds and shares of companies in emerging economies. These
developments took place in view of the level of our foreign currency investments, at over
CHF 570 billion, as well as our ongoing efforts to diversify our placements of them as broadly
as possible.
Investment in Chinese government bonds
In July 2014, the SNB communicated that it had been granted a renminbi investment quota by
the People's Bank of China (PBC). The investment quota amounted to RMB 15 billion, or
somewhat more than CHF 2 billion. This made it possible for the SNB to invest in the market
for Chinese government bonds, which is the fifth largest in the world, for the first time.
Experience so far has shown that the market is sufficiently liquid and that trading and
settlement of transactions works smoothly. As is the case for our other investments in the Asian
region, the operational side is handled by our Singapore branch. As it continues to open up,
the Chinese bond market is likely to become even more attractive for foreign investors in the
future. For instance, in July 2015, the PBC announced that public sector investors, which
includes central banks, are to be granted unlimited access to the Chinese bond market. In
place of investment quotas, they will merely need to be registered with the PBC.
Shares of companies in emerging economies
Since the beginning of the year, the SNB has also been investing in shares of companies in
emerging economies. In view of the growing importance of these countries for the global
economy and financial markets, this was an obvious step in further diversifying foreign
currency investments. With this move, the SNB is now covering most of the market
capitalisation of the global stock markets. The decision to invest in the shares of companies in
emerging economies was taken during the regular review of our investment policy. It is guided
by longer-term risk/return considerations and is independent of short-term developments on
the financial markets. Equity investments in emerging economies are managed passively, in
the same way as those from advanced economies, by replicating a combination of different
indices. Overall, however, these investments only account for a modest proportion of total
equity investments.
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