Monday 12th October saw the Bank of England (BoE) publish its latest Dear CEO letter, this time focusing on operational readiness for a zero or negative Bank Rate. This follows the Bank signposting the need to consider the appropriateness of a negative official Bank Rate during its August Monetary Policy Committee (MPC) meeting.
The Bank has provided a voluntary questionnaire requiring a one-month turnaround for firms to complete, asking both qualitative and quantitative questions across areas including:
- Strategy, process, and governance for implementing both short term tactical and longer-term solutions for zero and negative rate scenarios
- Third Party supplier dependence for system fixes
- Impact on firm important Business Services identified as part of Operational Resilience considerations
- Time and cost considerations for both short term tactical and longer-term solutions for zero and negative rate scenarios
- Granularity of data (e.g. decimal places) where changes are made
- Differences in preparations between “Flat” vs “Tiered” approaches to a Negative Bank Rate
Whilst none of this should come as a surprise for firms given signs from policymakers that this was very much a weapon in their armoury, we would stress the importance of giving this full consideration, regardless of whether your firm intends to respond to the BoE.
Previous lessons from the Global Financial Crisis from 2007 to 2009 showed firms experienced challenges with systems due to the potential of negative interest rates. An example of this was one bank’s mortgage tracker deal at Bank base rate minus 1.01%. When the base rate went to 0.5%, on paper this suggested they would be required to pay the customer at 50bps.
The reality was legal protections in the agreement meant the bank was only ever exposed to a floor of zero interest. However, the bank’s system was unable to process a zero rate, meaning a token 0.01% payment had to be taken and then credited back to the customer. Such manual processes proved unnecessarily time consuming and was an unnecessary distraction at a time when other challenges around loan books were presenting themselves.
FourthLine’s own perspective is for firms to consider:
- What priority processes would be fundamentally reversed by moving to negative rates
- Whether rate floors and other clauses exist in agreements that protect the firm from having to pay out, or alternatively charge interest, in a negative rate environment
- Whether existing systems allow zero or negative rates to be applied or whether manual workarounds are required
- Whether Third Party suppliers are aware of any previous challenges around negative or zero rates where their systems are part of critical infrastructure
- Who currently owns management of rate changes under their SMF accountability and whether they can attest to having rigorously oversighting the impact of negative rates
Our Operational Resilience insights deck contains information about identifying and assessing your Important Business Services. Click here to download the Operational Resilience Insight Deck