Q&A: So what is a 'negative interest rate?'

Usually people have to make regular interest payments to their lenders when they borrow money. Under a system of negative interest rates this relationship would be turned on its head and the lender would pay the borrower for the privilege of lending.

So why would people lend in those circumstances?

They wouldn’t – that’s the idea. The Bank of England is examining the case for charging interest on the funds that commercial banks hold on deposit at the central bank in order to encourage these high street lenders to do other things with the money, such as lend it to companies and households.

Why aren’t the banks doing this already?

They are still traumatised by the 2008-09 financial crisis when many of them almost went bust. They want to keep large amounts of “liquid” reserves at the central bank so that if they get into trouble again they can bail themselves out.

But isn’t that prudent behaviour?

The Bank of England and the Financial Services Authority think the banks have taken prudence to a fault – and that the real economy is suffering as a result. While the banks hoard reserves, they are not lending enough. The amount of credit in the economy is still contracting. This is one of the reasons why the economy has barely grown since 2010 and that we now teeter on the brink of a triple dip recession.

So what’s the catch?

Some analysts warn that if the regulators were to hit the banks with negative interest rates on their central bank reserves the result would not be a healthy surge in lending, but some nasty charges for bank customers. The banks’ profits would automatically fall and they would seek to recoup this by cutting the sums they pay to savers, or even seeking other forms of revenue such as imposing charges on anyone who has a normal current account.

So wouldn’t the Bank of England be mad to do it then?

Not necessarily. Although Bank of England officials never admit it in public, monetary policy has been ultra-loose since the 2008 financial crisis precisely because policymakers want to penalise saving and encourage saving. They think that too many people and firms are paying down debt at the same time, undermining the economy. They want to encourage spending not saving.