"Penalty interest" is the term used to describe bank interest rate offers that effectively correspond to a return of less than zero percent per year. Simply put, a saver pays the bank money to be allowed to store their savings in an account.
Penalty interest rates are of course not always levied under this title, but are sometimes referred to with euphemisms such as "deposit money". Account maintenance fees are also often not seen as penalty interest, but effectively amount to the same thing.
Why do banks issue penalty interest rates?
To understand the background of penalty interest, it is necessary to briefly consider the business model of banks. The classic business of banks is to borrow money and reinvest it. This is largely done through loans to individuals and businesses.
Banks use two main methods to obtain money:
- Open accounts for private and institutional clients and receive deposits
- You borrow from other banks
Banks face the same challenge as other businesses: if you don't get money, banks can't operate. Typically, banks therefore pay your customers money in the form of interest on their deposits. They are a motivation to invest their own money with the bank in question and not elsewhere.
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In recent years, however, banks themselves have had less and less incentive to collect account deposits. The reason is the current monetary policy of the european central bank (ECB), which was worked out to contain the global financial crisis since 2007.
In previous financial crises, "credit crunches" had occurred, which had a fatal effect on the economy. Banks got into difficulties or became more cautious, which is why they granted significantly less credit than before. As a result, companies refrained from investing or even went bankrupt, while private individuals consumed less. The economy slumped.
The ECB would now like to prevent such a situation. In june 2014, it introduced a negative deposit rate for banks that want to park money with the central bank in the short term. You are therefore "penalized" for saving funds instead of making them immediately available to the economic cycle. Meanwhile, the penalty interest rate of the ECB is 0.4% (as of november 2019). Furthermore, banks can borrow money from the ECB for zero percent interest.
The aim of this policy is simple: to force banks to lend more to the business community and at the same time provide it with sufficient funds. At the same time, the zero interest rate policy makes it easier for indebted european countries to refinance themselves cheaply and consolidate their budgets.
As a result of ECB intervention, banks can borrow money cheaply from other banks and afford to extend low-interest loans. Other banks must follow suit to remain competitive. Margins in the traditional lending business are shrinking.
It is therefore hardly worthwhile for banks to attract further deposits; instead, they are struggling to cover their costs. Penalty interest rates are a way to pass on some of the costs to savers.
How long should penalty interest rates last?
Presumably, as long as the negative interest rate phase continues. No reversal of the trend is foreseeable at present. The economies of the european states are not yet growing stably and many countries continue to be enormously indebted. An increase in lending rates could potentially lead to a new crisis.
In june 2019, the ECB told the public that there would be no "interest rate turnaround" until at least mid-2020.
Are there penalty interest rates on all bank deposits?
No, but they are not an exceptional phenomenon either. If account maintenance fees are also taken into account, around 23% of all german institutions charge negative interest on retail deposits (source: bundesbank monthly report). Negative interest rates are already considered "standard practice" for corporate customers.
In addition, even overnight and time deposits that pay positive interest rates are not necessarily profitable. Because when interest rates are below the rate of inflation, the invested assets effectively lose purchasing power. Experts speak in this case of "negative real interest".
What can savers do to escape penalty interest rates of your bank?
Change the bank
An obvious step is to move the account to a bank without penalty interest rates. Whether this strategy will be successful in the long term, however, is questionable. Many german banks currently have a liquidity surplus and further deposits bring more costs than profit opportunities. If too many customers want to move their money to a particular bank, the bank is likely to introduce negative interest rates as well.
Use interest portals
Platforms such as weltsparen and zinspilot give private individuals the opportunity to open accounts with banks in other european countries. They often still offer positive interest rates because they do not suffer as much from liquidity surpluses as german institutions do.
The corresponding offers are also protected by the european deposit guarantee, but with national funds. The security of the investment is thus indirectly dependent on the creditworthiness of the respective state, which means that investors may have to take somewhat higher risks.
Part of the assets that are not to be used as a liquidity reserve can be invested in capital assets.
Investors should be aware of the rule of thumb known as the "magic triangle of investing," which states that attractive returns are only available as a premium for risk of loss or a long capital commitment.
In the low-interest phase, a long investment period is not enough to give investors a return above the level of inflation. To do this, you must consciously take risks with your investment.
If they are prepared to do so, equities and bonds, but also alternative forms of investment such as tangible assets and crowdinvesting, are an option.
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