Are negative interest rates a signal of excessive liquidity?

International Monetary Fund warned on increased risks to financial stability in the Global Financial Stability Report released on 16 July, 2012. Excessive European sovereign debts and concerns about the quality of banks assets were mentioned as the main threat to financial stability alongside with the uncertainties on the fiscal outlook and federal debt ceiling in the United States. Financial risks are understood as possibility of losing assets. So, shouldn’t quality of assets remain the main focus and concern?

It could be mentioned that prominent features of June and the first part of July involved further easing of global monetary policies. According to the Monetary Policy Meeting held in June 15, Bank of Japan will encourage the uncollateralized overnight call rate at around 0 to 0.1 percent. The US Federal Open Market Committee decided to continue purchasing Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. The news about the expended operational twist by $269 billion through 2012 was announced on 20 June. The key ECB interest rates were cut by 25 basis points to 0.75% on 5 July. Monetary Policy Committee of Bank of England decided to increase size of Asset Purchase Programme by £50 billion to £375 billion on 5 July. The People’s Bank of China decided to cut one year RMB benchmark deposit and loan rates by 0.25 and 0.31 percentage points to 3% and 6% respectively on 6 July.

Similar remarks could be addressed to the quality of decisions in financial sector. Single supervisory mechanism for euro area banks and the concept to recapitalize banks directly through the European Stability Mechanism (ESM) may fail if banks’ business models are dysfunctional and they cannot sustain financial shocks. Banks’ insolvency arose due to inaccurate assets management and failed estimations. So, additional banks capitalization and facilitated access to attractive borrowing costs will hardly improve the assessment of viability of business plans/investment opportunities.

Moreover, could negative interest rates signal that liquidity is enough in the markets? Investors demand for credibility allowed Germany, Denmark, Finland, Belgium and France to borrow at negative interest rates. When investors chose sovereign bonds with negative interest rates they sink their savings. So, maybe liquidity is already enough and the main concern is to employ existing capital efficiently.

Could leaders of highly regulated institutions be easily replaced?

The FSA has announced about the misleading sales of interest rate hedging products to some SMEs on 29 June and confirmed that it reached agreement with Barclays, HSBC, Lloyds and RBS to provide appropriate redress where mis-selling has occurred. Barclays was fined £290m by authorities in the UK and the US following an investigation into the submission of various interbank offered rates. Chairman of Barclays, Marcus Agius resigned on 2 July, Chief Executive Bob Diamond and Chief Operating Officer Jerry del Missier resigned on 3 July. So, is it difficult to replace leaders of highly regulated and self–running business?

According to the FSA sold interest rate protection products involved “caps” those fix the upper limit to the interest rate on a loan and more complex derivatives such as “structured collars” which fixed interest rates within a band but introduced a degree of interest rate speculation. The investigation at Barclays revealed that some interest rates submissions reflected individual traders’ positions instead of the cost of interbank borrowing. However, its LIBOR submissions were relatively higher than in other banks during the credit crisis period which reflected appropriate management of structural risk, the risk that it may not be possible to decrease administered savings rates in line with decreases in money market (LIBOR) rates, resulting in a margin squeeze where lending is LIBOR-based.

So, is it difficult to find candidates those could prevent mistakes in the future, candidates with integrated knowledge of financial products, business operations and risk management expertise and maybe the most important feature – clear understanding of the role of financial institutions in economy?